The state deficit forecast: what's the real figure?

Why forecasters have so much trouble getting it right, and why the Washington deficit for the next biennium is $2 billion less than the $5.1 billion normally cited.

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Why forecasters have so much trouble getting it right, and why the Washington deficit for the next biennium is $2 billion less than the $5.1 billion normally cited.

Just days ago, the state’s chief economist, Arun Raha, sliced another $780 million from expected tax collections through June 30, 2013. The number includes $80 million from the current fiscal year, which has been in the red for months. The projected budget deficit for 2011-13 now swells to as much as $5.1 billion. The situation, while bad, is not that bad. The real figure is about $3 billion, as I'll explain below.

According to custom, the March forecast is the final piece of the fiscal puzzle to drop before legislators get serious about writing a budget. It supposedly marks an end to the uncertainty and speculation (and wheel-spinning) by giving lawmakers a clear idea of how much money they’ll have to work with in the coming budget cycle.

But it doesn’t. As Raha said in comments prefacing his March 17 forecast, “The economic outlook remains clouded with a great deal of uncertainty.”  It’s been cloudy for a while. Since lawmakers adopted the biennial budget two years ago, estimated collections have fallen nearly $2.5 billion.

Forecasting is the art of anticipation. Like skeet shooters, analysts track the target, lead it a bit, and squeeze the trigger. It’s all about recognizing the arc and aiming just ahead of it. Predictability is the key. Zigs and zags, spikes and dives, turn the sport into a game of chance. Hits are rare. Misses rule.

Across the country, missed revenue forecasts are the norm. A recent joint analysis by the Pew Center on the States and the Nelson A. Rockefeller Institute of Government found that “in 2009 fully 70 percent of all forecasts overestimated revenues by 5 percent or more…The median error was a 10.2 percent overestimate.” Despite significant improvement in 2010, the Pew-Rockefeller analysts say the long-term trend is “that overestimates have gotten larger during each of the past three economic downturns, and more states have made them.”

University of Tennessee economist William Fox, who participates in that state’s forecasting process, tells Pew-Rockefeller, “Whenever I testify on this topic, I say I’m going to be wrong. The only question is, how wrong am I going to be?”

Raha’s track record beats many of his peers, though that may be small consolation to frustrated budget writers. The certainty they’re looking for doesn’t exist in a dynamic economy and turbulent world.

Last week, he gave a 20 percent probability to the pessimistic forecast, 10 percent to the optimistic, and 70 percent to the baseline. Carefully, he cited “geopolitical developments” including oil price volatility heightened by unrest in the Middle East and North Africa and  the impacts of the earthquake and tsunami in Japan.

To these uncertainties, add the Pew-Rockefeller finding that the primary factor driving forecast errors is “the volatility of the revenues streams themselves.” The analysts point to reliance on income and capital-gains taxes, shifts in consumer spending, and the continuing restructuring of the nation’s industrial base.

While Washington doesn’t have the unstable income and capital-gains taxes, we’re not immune to the vagaries of consumer spending — more important here because of our consumption-based tax structure — and an evolving economy.

Even as personal income growth returned over the last year, consumer spending remained restrained as households paid down debt, built savings, and replenished retirement accounts. No one knows when or whether consumers will revert to past patterns. But it’s unlikely anytime soon. Surveys show consumer confidence has fallen again in recent weeks. Rising gas prices and high unemployment suggest continuing frugality.

Another example of the growing challenges facing forecasters came out last week as Raha noted a revenue department estimate that the continued increase in online sales escaping taxation total $740 million.

Lawmakers facing a multi-billion dollar shortfall will want to spend everything Raha has identified for them. They shouldn’t. Remember, he also said downside risks are twice as high as upside risks. Take that seriously and you leave a little extra in reserve.

Conservatively, the forecast numbers mean that balancing the budget will require about $3 billion in serious cutbacks. The widely cited $5.1 billion shortfall, routinely reported as fact by the media, is inflated by about $2 billion for programs not currently funded and which no one ever expected to see in 2011-2013.

Specifically, the two ballot issues passed in 2000 to reduce class size and increase teacher salaries were suspended in the current budget, as they have been most years, since these were ballot measures passed without revenue sources for them. While scheduled to return in 2011-13, they certainly won’t. Together they add nearly $1.2 billion to the "shortfall."

Moreover, last year lawmakers adopted a costly education finance reform measure that, if funded, adds $700 million to the shortfall. It’s easier to cut or defer programs before they get started, so this too it won’t happen. That’s $2 billion off the top.

But when you peel back these easy maneuvers, you’re still left with a $3 billion shortfall. Gov. Chris Gregoire, who has been steadfast in foreswearing gimmicks and tax hikes, proposed a balanced budget that shows us what the solution resembles. Nothing emerges unscathed: Higher education, public schools, health care, social services, corrections, environmental and natural resource programs — all face spending reductions. Further, she negotiated modest pay cuts and a slight increase in the employee share of health care benefits.

Predictably, Gregoire said she didn’t like her budget and most lawmakers agreed with her. While no one expected good news in the March forecast, as long as the number was in doubt, denial remained possible.

At some point, pragmatism and resignation look a lot a like. This session, Gregoire has been the pragmatist. Last November, voters established a high bar for new taxes. The few remaining budget tricks don’t generate a lot of cash and they will magnify future problems. Over the next few weeks, lawmakers will conclude that the governor offered the budget she did because she had no other choice.

Neither do they.


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