Revenues Miss the Mark: How Inaccurate Projections Skew California’s Budget Process
The budget process relies heavily on the Department of Finance’s (DOF) series of budget projections for the coming year, shaping the Governor’s budget and framing the larger debate surrounding it. In particular, January’s budget projections are significant because the Governor’s proposed budget serves as the official starting point for budget debates. Therefore, when inaccurate projections shape the budget, the discourse surrounding it becomes farther removed from reality.
Throughout the budget process, the DOF releases several sets of short-term budget projections: those accompanying the Governor’s proposed budget in January, those accompanying the revised budget in May, and those accompanying the enacted budget in June.
Over the last decade and a half, January’s General Fund revenue projections for the coming fiscal year have been routinely inaccurate and less accurate than revenue projections included in June’s enacted budget. Since 1997-98, actual revenues have been within 2% of January’s projected revenues only two times.i By comparison, June’s projections have been within 2% of actual revenues six times. The median error for January’s projections is 4.7%, compared to June’s median error of 1.6%.
Still, when actual revenues differ from projections by even 2%, that error amounts to about $2 billion, which is equal to nearly a tenth of the state’s higher education budget. Certainly, inaccuracy encompasses both overestimations and underestimations of revenue totals. But because California generally maintains either a small or no reserve, when shortfalls do occur, they cause immediate cash flow difficulties for the state. Whereas revenue excesses generate questions about how to most effectively use those revenues, revenue shortfalls generate questions about where the state must cut already budgeted spending.
Over the last decade and a half, revenue excesses have occurred more frequently than revenue shortfalls, but the revenue shortfalls have tended to be larger in magnitude than the excesses. The shortfalls have averaged $10.1 billion and been as large as $20.1 billion (2008-09). On the other hand, the excesses have averaged $5.0 billion and topped out at $11.7 billion (1999-00). Because revenue shortfalls have been twice as large as excesses on average and have driven cash flow shortages, their impact on their budget has been compounded.
Moreover, January’s projections have become increasingly over-optimistic over the course of the last 15 years. From 1997-98 to 2001-02, the projections were lower than actual revenues by an average 5.9%. From 2002-03 to 2006-07, the projections were lower than actual revenues by an average 7.1%. But from 2008-09 to 2011-12, the projections were higher than actual revenues by an average 5.5%. Overly optimistic projections further drive budget uncertainty and unexpected cuts.
Inaccurate estimates of revenue level changes from the previous year further complicate the budget process. Over the last decade and a half, the state has predicted that its revenues would exceed those of the previous year 94% of the time. In most of those cases, revenues were indeed higher than the previous year, but the estimates themselves were largely inaccurate.
In several cases, the estimates of increases over the previous year were quite inaccurate. For instance, for 2001-02, the governor’s January budget projected a 16.4% increase in revenues, but actual revenues increased only 1.1% a 15.3% error. For 2010-11, the January budget projected an 8.6% decline in revenues, but the state actually experienced a 7.4% increase a 16.0% error. And for 2008-09, the Governor’s January budget projected a 1.6% increase in revenues, but actual revenues declined 19.3% a full 20.9% error.
Errors of this magnitude are significant because so much of the budget process deals with year-over-year budget changes. The budget compares its proposed funding for each program area to its funding for the previous year. So when the budget calls for an additional $1.6 billion in funding to various program areas, but the state brings in $19.8 billion less than the previous year, there comes a scramble to correct for the $21.4 billion in over-budgeting. Consequently, planned reductions may be larger and planned increases may smaller, if not eliminated entirely. And when the legislature legally cements future spending policies based on projected revenues that never materialize, other programs and services consequently absorb the budget cuts instead.
When the DOF makes its projections, it sometimes discusses uncertainties and alternative scenarios that could affect actual revenue levels. This raises questions about how California’s lawmakers shape budgets in light of projection inaccuracies and possible alternative outcomes. Former economists for the Legislative Analyst’s Office Jon David Vasche, Brad Williams, and Robert Ingenito wrote, Although such alternatives have been useful in providing lawmakers with perspectives about uncertainties inherent in the fiscal outlook, policy makers have not used them explicitly in the development of the budget. Decisions about how to respond to changes in the budgetary outlook have usually been make after rather than before their occurrence.ii
When it comes to the DOF’s January revenue projections, actual revenues are almost always off target by at least several billion dollars and can be off by tens of billions of dollars. More frequently than not, January projections underestimate revenues for the coming year, generally resulting in relatively small excesses. However, when projections overestimate actual revenues for the coming year, the resulting shortfalls tend to be greater than the excesses. Lacking a reserve, it is in these years that the state’s budget is hit the hardest by unanticipated shortfalls and responds with subsequent cuts to programs and services.
Works Cited [+ Expand]
i All cited actual and projected revenue data originated with the California Department of Finance (DOF) website when available. Projected revenue for years prior to 2001-02 was not available from DOF directly, so we used DOF figures cited by the LAO in its annual Budget overview documents.
‘schedule A: Historical Data, General Fund Budget Summary. California Department of Finance. State of California, July 2012. Web. 7 January 2012. <http://www.dof.ca.gov/budgeting/budget_faqs/information/documents/Chart-A.pdf>.
Governor’s Budget Summary, 2001-02 to 2011-12. California Department of Finance. State of California. <http://www.dof.ca.gov/budget/historical/>.
Overview of the Governor’s Budget, 1996-97 to 1997-98. California Department of Finance. State of California. Web. <http://www.lao.ca.gov/laoapp/main.aspxtype=2&PubTypeID=2>.
ii Vasche, John D., Brad Williams, and Robert Ingenito Budget Forecasting for the State of California. Government BudgetForecasting: Theory and Practice, Ed. Jinping Sun and Thomas Dexter Lynch. Boca Raton, FL: Auerbach Publications, 2007. 71.