Opinion: New Jersey Needs to Change How it Forecasts Revenue

Richard F. Keevey | March 4, 2019 | Opinion
If we switch to the model used by most other states, the emphasis then would be on the appropriateness of tax and spending policies and not on competing guesses about revenue

Credit: Amanda Brown
Richard F. Keevey
Tomorrow, Gov. Phil Murphy will present his proposed budget for fiscal year 2020 to the Legislature and the public. As part of this process, Murphy will forecast what his administration expects in terms of state revenues for the year. It is one of the most critical elements of the entire budgetary process so it should be recognized as an area with potential manipulation for political gain.

I recommend the responsibility for forecasting revenue be broadened beyond the governor to reduce risk and to zero in on the objectives of what the state can spend and overall tax policy.

The overview

In the New Jersey budget process only the governor has the constitutional authority to certify revenue. The governor takes advice from professional staff and considers revenue estimates from the Legislature when it delivers the final appropriations bill. But, in the end only the governor certifies the estimate. For several reasons, such a process can and should be improved. But first, some observations.

Revenue forecasting plays a critical role in the development of the budget. It establishes the resource baseline which expenditures must be within if the ensuing Appropriation Act is to be sustainable.

One thing for sure — forecasts will be wrong because the future is unknowable. We should strive for the process to be objective and realistic because both over- and under- estimates create significant but different policy and political problems. “Realistic” means it fits the known facts and has a high probability of how the revenue flow will play out over the fiscal year.

When I was budget director — working with excellent forecasters — we advised governors on what should be certified. I always thought: “We prepare the forecast; we put the numbers into a tracking system and wait for collections to prove us wrong because inevitably we would be.” Experienced revenue forecasters seek forecast accuracy but understand their forecasts will be wrong. This suggests an interesting tension in the process — the forecasters are hopeful but expect to be wrong; those outside the process expect the process to be right.

No matter how confident the forecasting team is that revenue estimates are reasonable, reality sometimes delivers an unfortunate surprise. That is the nature of the process; excellent forecasting cannot escape the clutches of randomness or quick-changing economic events.

The current process

Revenue estimating is based on two primary sources of information — economic trends at the national and state level and state collection patterns. State collections are by far the most important because they are both more timely than economic data and more tied to the state’s economy. Sales tax and personal income-tax withholdings and estimated payments are real-time reflections of the state economy. Close monitoring of the monthly collections, especially those in September, January and April when the bulk of the revenue comes in are the backbone of the forecasting process. The data is essentially used to monitor the forecast incorporated in the current year’s budget as well as provide the basis for projecting the next six to 18 months of revenue.

The timeline for the current New Jersey revenue estimating process can be illustrated by the budget preparation for Fiscal Year 2020 which begins July 1, 2019.

  • July 2018: Revenue for FY 2019 is certified, and preliminary economic projections and revenue estimates are developed by the executive for FY 2020. Collections for FY 2018 are analyzed (the books actually stay open for an additional month) and final collections are tabulated. The first significant collections for FY 2019 become available in mid-October. The preliminary Annual Financial Statements for FY 2018 should be available by November with final revenue numbers for FY 2018.
  • January 2019: The governor’s budget for FY 2020 is near completion. Revenue collections for December and early January are available, providing insight into how good or bad the prior calendar year was and what may be in store for the upcoming April income-tax collections. Depending on collections and an update on the economy, revenues for the current year may be maintained — or most likely increased or decreased. The final estimates are reflected in the FY 2020 Budget.
  • February-March 2019: The governor delivers the FY 2020 budget, including estimated revenue for FY 2020 and revisions to the current year (FY 2019).
  • March–May 2019: The Legislature reviews the governor’s FY 2020 budget and conducts hearing with the departments. The Office of Legislative Services analyses the governor’s revenue estimates and develops its estimates.
  • May-June 2019: The State Treasurer appears before the House and Senate budget committees and presents updated estimates, incorporating the results of the April collections for the current year — and for FY 2020.
  • June 30, 2019: The Legislature makes changes to the governor’s budget and submits the final Appropriation Act to the governor, most likely with revised revenue estimates.
  • July 1, 2019. The governor signs the Appropriation Act for FY 2020, including the certification of revenue. The certification may be the same as proposed by the Legislature or a new set of numbers. The governor may or may not line-item veto certain appropriations.
  • Some of the issues

    It is certainly possible that there is no difference in revenue estimates between the governor and the Legislature — or the difference is so minimal that it does not matter. Or, there could be wide variances.

    There have been wide variances in the past. In one case in the early 2000’s, the difference was so wide that it resulted in significant revenue shortfalls causing unfortunate mid-year reductions. Remember, the budget must be balanced in the end regardless of the estimates. The shortfall was so dramatic it impacted budgets for several subsequent years.

    So, why would a governor (any governor) inflate or lowball the revenue estimates? It is very important to remember that the budget is a fiscal plan as well as a political document. So, the selection of a revenue level could be of direct importance to meet a political goal. One may wish to restrict the size of government by choosing the most conservative forecast; others may elect for optimistic assumptions that make additional spending programs or tax cuts appear more favorable.

    Revenue monitoring is also an important function to ensure that estimates are on target. Such a function is the role of the executive branch since it collects taxes and other revenues. Changes in when or how payments must be made can change the period in which revenue is collected. For example, the flow (not the totals) of income-tax collections last fiscal year and this year is significantly impacted by the federal tax-code changes. So, a simple comparison of year-to-year collections is neither desirable nor realistic.

    To address this issue, a creation of monthly targets used for tracking progress is critical to ascertain if collections are on target. But setting useful targets is not easy. Monthly forecasts are also forecasts and are more sensitive to random fluctuations than annual estimates. They can also be manipulated by back loading, i.e. keeping targets low early in the fiscal year to avoid public awareness of shortfalls.

    New Jersey’s Treasury department does not publicly release this monthly data, but rather issues random reports (not monthly) that compare collections from year to year. To monitor properly revenue estimates, these reports must be issued monthly and include collections to date versus monthly targets and year-to-year comparisons. Such comparisons are imperative so if there are shortfalls corrective actions can be taken before it is too late. This process should be improved.

    A recommendation

    New Jersey should establish a “Revenue Estimating Board” so that revenue estimating can be accomplished in a more collaborative manner between the executive and legislative branches. Ideally, such a board should be mandatory, but the state constitution states that only the governor can certify revenue.

    To change the constitution is time-consuming, complicated and creates unnecessary animosity between the branches of government. Rather, New Jersey should enact legislation to establish a “Revenue Estimating Board” whose job would be to recommend to the governor what level of revenues should be certified. If the governor chooses to certify a different number, for whatever reason, he or she must state why they have chosen a different set of numbers.

    I make no recommendation as to the exact composition of the board. Some suggest a group of three — one from the executive, one from the Legislature and a neutral third party. Other states have larger configurations including economic experts, university faculty and private-sector experts. But to be effective, this board must meet at least twice per fiscal year (January and May) to review revenue collection trends and the analysis presented by the executive and legislative professional forecasting staff.

    The Volcker Alliance, a national group dedicated to advancing budget management of states, grades New Jersey ‘D’ in the category of budget forecasting, principally because of lack of a consensus on a forecasting model. It is time for New Jersey to change its model from dependence on choices by the executive branch to a more transparent and inclusive model; most states do.

    Let the budget debate be about the appropriateness of the tax and spending policies and not about the competing revenue guesses. Obtain an objective assessment of what the state can spend and then debate how best to spend that amount.