State Revenue Forecasts

Updated October 2009

Contents
Introduction
The Revenue Forecast Process
A Revenue Forecast Table
Forecasts and Results, 1999-2009
Keeping Track Month by Month

Introduction
Three times in every two years, Indiana forecasts revenues for future fiscal years. These revenue forecasts are needed for the budget process. The General Assembly must know how much revenue will be available in order to decide how much to spend.

Unfortunately, predictions are never perfect. Revenues came in above projections throughout the second half of the 1990s.  Starting in fiscal 2000, revenues fell short of projections.  The shortfalls became huge in 2001, 2002 and 2003. This was the main source of Indiana's budget difficulties during the first half of the decade. Then, from fiscal 2005 to fiscal 2008, the economy recovered, and revenues exceeded projections again. But another recession began, and in fiscal 2009 revenues fell well short of forecasts.

The Revenue Forecast Process
In every odd-numbered year, the Indiana General Assembly meets in a "long" session, to write a state budget for the next two fiscal years. A budget is a spending plan, a decision to authorize state agencies, departments and institutions to spend particular dollar amounts. Before the legislature can know how much spending to authorize they must know how much they’ll have to spend. That means estimating future revenues from state taxes.

Revenue predictions are made three times every two years. The first predictions for an upcoming biennium are usually made in December prior to a budget-writing year. In December 2008, for example, the state revised its prediction for the rest of fiscal 2009, and made its first predictions for 2010 and 2011. In April of a budget-writing year, just before the budget is passed and the session ends, a revised forecast is made. This allows the legislature to include new information about actual revenue collections in December through March. Such a forecast was made in April 2009, for the remaining months of fiscal 2009, and revised forecasts for 2010 and 2011.

In April 2009, however, the Governor and many legislators were dissatisfied with the revised forecast, think that it was too optimistic in the face of the deep recession. This is one reason why a budget was not passed by the regular session deadline at the end of April. A new more pessimistic forecast was developed in May, for the special session, and this forecast was the basis for the budget that passed on June 20, 2009.

The next forecast is scheduled for December 2009, before the non-budget "short" session. Forecasts for the remainder of fiscal 2010 and for fiscal 2011 will be revised again.

Indiana’s way of projecting revenues has one big advantage. Indiana makes a "consensus forecast." Representatives of the Governor’s office, both houses of the General Assembly and both parties all agree on the projections before they are announced. Without a consensus forecast, the Governor’s office might announce one set of projections, and the legislature another. Each political party could have its own, and lobbyists might chime in with projections too. Much of the session’s debate would be about which projections to use, not on the substance of legislation. Getting a consensus on revenues before the session begins lessens this problem (though, as 2009 proved, it does not eliminate argument about forecasts).

The projection process moves forward along two tracks. A private forecasting company, IHS Global Insight, provides detailed projections of indicators for the national and Indiana economies. (IHS is a company that acquired Global Insight in October 2008.) Meanwhile, a group called the Revenue Forecast Technical Committee works on models of Indiana revenues. This committee is composed of the fiscal aides to the House and Senate party caucuses, an appointee of the governor (currently an economist from Indiana University), and the chief revenue forecaster from the State Budget Agency. For the special forecast in May 2009 two outside consultants were added to the committee. The revenue models are developed by the Budget Agency and by the Legislative Services Agency, with some help from an economist at Purdue University (who also writes this webpage).

The models relate Indiana revenues to the economic indicators that Global Insight predicts. Data from past years are used to measure the revenue relationships. The sales tax model, for example, is an equation that relates sales tax collections to Indiana personal income. The models change a bit every year, but in December 2009 each 10% increase in Indiana income was predicted to increase sales tax revenue by about 10%. Models are developed for the sales tax, individual and corporate income taxes, and the cigarette, alcoholic beverage and riverboat wagering taxes.

Each model is reviewed and approved by the Technical Committee members. This is how a consensus forecast is achieved, since the committee's members represent both parties, both houses of the legislature, and the governor's office. A day or two before the revenue forecasts are announced, the Technical Committee "plugs" the predicted economic indicators into the revenue forecast models. The result is the revenue forecast, which is announced to the legislature and the public and is always well-covered by the news media.

A Revenue Forecast Table
The following table compares revenue forecasts in each year with the actual revenues collected.  Each row shows the successive revenue forecasts and the final revenue for a fiscal year.  The first set of columns shows the April forecast, made just before the budget is passed.  This is the revenue that was expected for that fiscal year, at the time that the year's spending decisions were made.  The second set of columns shows the subsequent December forecast, showing how revenue forecasts were revised after eight months.  The third set of columns show the actual revenues received in that fiscal year, and the difference between this actual figure and the original April predictions.  The last column shows the percentage change in actual revenues from one year to the next.

Consider the first row, fiscal year 1996 (July 1995 to June 1996).  In April 1995, just before the biennial budget for fiscal years 1996 and 1997 was finished, the revenue forecast committee set expected revenues at $7,099.1 million (just over $7 billion).  The legislature budgeted appropriations for fiscal 1996 with this figure in mind.  In December of 1995, almost half-way through fiscal 1996, the forecast was revised upward by $370 million to $7,469.1 million.  The Indiana economy performed better in the first half of fiscal 1996 than had been expected in April.  It did even better than that in the last half of fiscal 1996, and actual revenues turned out to be $7,513 million.  That was $413.9 million more than was forecast when the 1996 budget was written.  And it was 6.3% higher than revenues in fiscal 1995 (not shown). 

Twice during this period major changes were made in tax rates, so the April forecasts and the actual revenues are not comparable.  The sales tax increased from 5% to 6% in December 2002, which was five months into fiscal year 2003.  The sales tax increased again, to 7%, in April 2008, which was nine months into fiscal 2008. For these years a forecast of the added revenues from the higher tax rate is added to the April forecast, so that the are comparable to actual revenues. A shortfall would represent revenues less than the original forecast at the lower tax rate, and revenues less than what was forecast from the added rate.

Forecasts and Results, 1996-2011
We can use this table to tell the story of Indiana's revenues during the expansion of the 1990s, the recession of 2001 and after, the expansion in the middle of the decade, and the revenue troubles the state faced in 2009.

The economy grew rapidly in the United States and in Indiana during the second half of the 1990s.  For four straight fiscal years, 1996-1999, revenues came in substantially above the April forecasts.  Since spending was budgeted based on revenue forecasts that were too low, the state accumulated balances, topping $2 billion at the end of fiscal 1998.  The General Assembly scrambled to find ways to hold balances down, with additional spending (for highways and to fund teacher pension commitments, for example) and tax cuts (property tax breaks for personal property, an income tax deduction for property taxes on homes).  There was talk of a "structural surplus", which implied that taxes were high enough or the economy would grow fast enough to produce continuous increases in balances.

This era came to an end, suddenly, in fiscal 2000.  Actual revenue in 1999 was $8,883 million.  In April 1999 revenues for 2000 were predicted to be $9,302 million, and for 2001, $9,773 million, growth rates of 4.7% and 5.1% respectively.  It didn't happen.  By December 1999 the revenue forecasters realized something was wrong, and revised their forecasts for both 2000 and 2001 downward.  When the revenues for fiscal 2000 were added up at the July budget closeout, actual revenues were found to have been $9,143 million, $159 million less than the original 1999 forecast.  Revenues increased only 2.9% from 1999 to 2000, not the projected 4.7%. 

Then came serious trouble.  In fiscal 2001, only $9,052 million was collected, over $600 million less than the revised forecast from the year before.  All together, revenues for 2001 were $721 million less than the original forecast on which the budget was based.  Revenues had actually fallen from the year before, by one percent. 

The revenue forecast made in 2001 for the 2002-03 biennium assumed the worst was over.  Growth of around 5% a year was expected--$9,545 million in 2002 and $9,987 million in 2003.  The budget was written based on the expectation of this normal revenue growth. But again, 2002 was a revenue disaster.  Actual revenues fell $837 million short of the previous year's forecast.  Revenues had fallen for a second straight year, this time by 3.8%.  No one could remember a time when actual revenues had fallen two years in a row. 

The budget difficulties and the approaching property tax reassessment spurred the General Assembly to restructure taxes. Tax restructuring was completed in a special session in June 2002.  Sales, cigarette and riverboat gaming taxes were increased.

Forecasts of revenues from existing taxes and from the new higher sales tax again proved optimistic. Fiscal 2003 proved to be the worst year yet, with revenues falling short by $1.1 billion. Actual revenues increased 13.4% over the previous year, because of the tax rate increases, but this was well short of the growth that had been expected.

Projections for the fiscal years 2004 and 2005 were made in April 2003. Again, significant increases in revenues were expected. The big 7.5% increase expected between 2003 and 2004 was due partly to tax restructuring. The tax increases would be in place for the full fiscal year in 2004. But a substantial increase was expected in 2005 as well.

This time, the shortfall was small. Actual revenues fell short of the prediction by only $73 million in 2004. Despite this small shortfall, the revenue prediction for 2005 was revised downward by $190 million.

At the July 2005 closeout the Budget Agency reported actual revenues for 2005 at $11,437 million, $244 million more than originally predicted in April 2003. For the first time since 1999 actual revenues exceeded predictions. Revenues had grown 7.7% over 2004. During the budget session of 2005, revenues for 2006 and 2007 were predicted to grow by 2.8% and 5.3%, respectively. The state did better than that in both years. At the closeout in July 2006, the budget agency reported that revenues were $303 million above projections. In 2007, revenues exceeded projections by $248 million.

Indiana state revenues turned the corner in 2005. But the years 2000 through 2004 were a revenue disaster. In two of the years, 2001 and 2002, revenues had actually fallen from one year to the next. More important for budgeting, revenues had fallen $2.9 billion below projections during this time. The General Assembly uses these predictions to set appropriations for school aid, universities, Medicaid, corrections and all the other functions of state government. When they fall short, the state must use its balances, or spend less than appropriations. With a revenue shortfall this big, though, Indiana had no choice but to cut appropriation growth, and raise taxes.

The opposite is true when revenues exceed projections, as they did during fiscal years, 2005-08. The state can pay for its planned spending. rebuild its fund balances, and sometimes, appropriate more money for added services in non-budget years.

Fiscal 2008 saw revenues exceed projections by $113 million. That year also saw a sales tax hike which increased revenues at the end of the year. Revenues were 3.6% higher in 2008 than in 2007. Without the tax rate hike the increase would have been 2.4%. Actual revenues exceeded projections, but revenues had been projected to grow more slowly than they had in the middle part of the decade. The forecasts recognized the slowing economy.

A recession began in December 2007.  In the fall of 2008 the world financial crisis caused a severe economic downturn.  The December 2008 forecast revision responded by cutting predicted revenues for the 2009 fiscal year by $265 million. This gloomy forecast proved optimistic, and the results of the financial collapse rolled through the economy, and began to affect state revenues early in calendar year 2009.   By the end of the fiscal year, 2009 had been the worst year for state revenue in memory, falling short of projections by $1.4 billion. Revenues had fallen from 2008 to 2009 by 1.1%, despite the increase in the sales tax.

The forecast for 2010 predicts slower-than-usual growth in revenues, at 1.6%, from a depressed starting point after the 2009 shortfalls. Growth in 2011 is predicted to be a modest 3.9%. As a result, the budget written for the 2010-11 biennium is very tight, and the prospects for the next biennium are for more of the same.

Keeping Track Month By Month
Indiana's State Budget Agency publishes a report each month that compares actual revenue collections to projected collections. Monthly projections are derived from the annual projections based on historic monthly patterns of revenue collection. The reports show the difference between actual collections and projections each month. A total shows how collections compare to projections so far during the fiscal year.

Readers should know of a quirk in the way actual revenues are compared to forecasts. June's final report for the 2008 fiscal year shows revenue collections for July 2007 through November 2007 exactly on target. There is no difference between projections and actual collections. But go back to the November 2007 report, and you'll see the July through November revenue collections differ from projections every month. This is because the December 2007 forecast revision took actual collections from July through November as given. Earlier monthly forecasting errors are zeroed out.

In December 2008, however, the Budget Agency changed their approach. With the December 2008 forecast revision, all of the fiscal 2009 projected collection were reduced. The differences between actual collections and projected collections were not set to zero. Instead, since the revenue forecast for 2009 was reduced, all the differences became more positive or less negative.

As of September 2009, actual revenue collections were $254 million below forecast, based on the final forecast from May. The special May forecast was much more pessimistic than the regular April forecast had been, but, apparently, it was not pessimistic enough.

In October 2009 state budget director Christopher Ruhl sent a memo to the revenue forecast committee, calling the size of the forecast error "alarming." The memo speculated about future shortfalls ranging from $430 million to $2 billion for the whole 2010 fiscal year.

The memo asks some sensible questions about the economic environment. Are Indiana residents now going to save more and spend less, permanently, so that sales tax revenue growth will be permanently lower? Do falling income tax withholdings mean lower income tax collections for the coming year? When will the decline in income tax payments be reversed? Is the huge drop in corporate income tax payments likely to continue?

Forecasts ofrevenues in an environment of great change will be inaccurate. The only evidence available to forecasters is from the past, but if the past ceases to be a guide to the future, forecasters will have trouble.