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DECEMBER 2013

MANAGING UNCERTAINTY State Options for Smoothing Revenue Volatility

Why Does Volatility Matter?

• Influences timing and size of state budget surpluses and shortfalls

• Unpredictability confounds best efforts to craft and execute balanced budgets

• Smoothing volatility across the business cycle can lessen need for hardest budget choices

Key Findings

There is wide variation among states in how their tax revenues align with economic performance.

State economic factors—natural resources, the range of industries, population, and other characteristics—contribute to revenue volatility.

State tax policy—what and how states tax—can magnify or moderate underlying economic sources of revenue volatility.

-8%

-6%

-4%

-2%

0%

2%

4%

6%

1990

1991

1992

1992

1993

1994

1995

1995

1996

1997

1998

1998

1999

2000

2001

2001

2002

2003

2004

2004

2005

2006

2007

2007

2008

2009

2010

2010

20

11

2012

Some States Grow with the United States

Illinois Economic Performance versus United States, 1990-2012 Year Over Year Growth

Source: State coincident index, Federal Reserve Bank of Philadelphia

U.S. Illinois

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

20

11

2012

Other States Don’t

Source: State coincident index, Federal Reserve Bank of Philadelphia

-8%

-6%

-4%

-2%

0%

2%

4%

6%

1990

1991

1992

1992

1993

1994

1995

1995

1996

1997

1998

1998

1999

2000

2001

2001

2002

2003

2004

2004

2005

2006

2007

2007

2008

2009

2010

2010

20

11

2012

U.S. Alaska

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

20

11

2012

Alaska Economic Performance versus United States, 1990-2012 Year Over Year Growth

Economic Volatility Does Not Always Correlate with Revenue Volatility

Leas

t Ec

on

om

ic

Vo

lati

lity

Mo

st E

con

om

ic

Vo

lati

lity

40%

23%

What Drives Revenue Volatility?

Economic Characteristics

State Tax Systems

Federal Policy &

Catastrophic Events

What Drives Revenue Volatility?

Economic Characteristics

State Tax Systems

Federal Policy &

Catastrophic Events

MICHIGAN

Weak Economic Performance in the 2000s

Michigan Economic Performance versus United States, 1990-2012 Year Over Year Growth

Source: State coincident index, Federal Reserve Bank of Philadelphia

U.S. Michigan

-20%

-15%

-10%

-5%

0%

5%

10%

15%

Ju

l-90

Apr-

91

Ja

n-9

2

Oct-

92

Jul-93

Apr-

94

Ja

n-9

5

Oct-

95

Ju

l-96

Apr-

97

Ja

n-9

8

Oct-

98

Ju

l-99

Apr-

00

Ja

n-0

1

Oct-

01

Ju

l-02

Apr-

03

Ja

n-0

4

Oct-

04

Ju

l-05

Apr-

06

Ja

n-0

7

Oct-

07

Ju

l-08

Apr-

09

Ja

n-1

0

Oct-

10

Ju

l-11

Apr-

12

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

20

11

2012

NEW YORK

MICHIGAN

-6%

-4%

-2%

0%

2%

4%

6%

1990

1991

1992

1992

1993

1994

1995

1995

1996

1997

1998

1998

1999

2000

2001

2001

2002

2003

2004

2004

2005

2006

2007

2007

2008

2009

2010

2010

20

11

2012

Source: State coincident index, Federal Reserve Bank of Philadelphia

Economic Characteristics Shift

U.S. New York

1991 N.Y. Recession 2007 N.Y. Recession

New York Economic Performance versus United States, 1990-2012 Year Over Year Growth

NEW YORK

MICHIGAN

NORTH

DAKOTA

-6%

-1%

4%

9%

14%

1990

1991

1992

1992

1993

1994

1995

1995

1996

1997

1998

1998

1999

2000

2001

2001

2002

2003

2004

2004

2005

2006

2007

2007

2008

2009

2010

2010

20

11

2012

Specialized Economies

Source: State coincident index, Federal Reserve Bank of Philadelphia

Energy Industry Growth

U.S. North Dakota

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

20

11

2012

North Dakota Economic Performance versus United States, 1990-2012 Year Over Year Growth

What Drives Revenue Volatility?

Economic Characteristics

State Tax Systems

Federal Policy &

Catastrophic Events

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

Volatile Revenues Despite Stable Economy

Source: State coincident index, Federal Reserve Bank of Philadelphia; State tax collections,

Rockefeller Institute of Government, SUNY, Albany, N.Y.

Revenue

Economy

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

20

11

2012

Wyoming Economic Performance versus Tax Collections, 1995-2012 Year Over Year Growth

-12%

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

Volatile Economy, Stable Revenues

Source: State coincident index, Federal Reserve Bank of Philadelphia; State tax collections,

Rockefeller Institute of Government, SUNY, Albany, N.Y.

Revenue

Economy

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

20

11

2012

North Carolina Economic Performance versus Tax Collections, 1995-2012 Year Over Year Growth

-15%

-10%

-5%

0%

5%

10%

15%

20%

Revenue Volatility Intensified by Housing Industry Slump

Source: State coincident index, Federal Reserve Bank of Philadelphia; State tax collections,

Rockefeller Institute of Government, SUNY, Albany, N.Y.

Revenue

Economy

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

20

11

2012

Florida Economic Performance versus Tax Collections, 1995-2012 Year Over Year Growth

Nevada and Consumer Spending

• State derived more than two-thirds (68%) of tax collections from three sources in 2012: General sales tax, amusements tax, and motor fuels tax

• Over 50% of tax collections in 2012 were generated by general sales tax

• General sales tax collections dropped by more than 23% between 2007 and 2010 in response to depressed consumer spending

Source: U.S. Census Survey of State Government Finances

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

35%

Difficult Budget Response to Recession

Source: State coincident index, Federal Reserve Bank of Philadelphia; State tax collections,

Rockefeller Institute of Government, SUNY, Albany, N.Y.

Revenue

Economy

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

20

11

2012

Impact of Tax Increases

Nevada Economic Performance versus Tax Collections, 1995-2012 Year Over Year Growth

What Drives Revenue Volatility?

Economic Characteristics

State Tax Systems

Federal Policy &

Catastrophic Events

Federal Budget Uncertainty

Prospect of Long Shutdown Stokes Concern

— October 04, 2013

Handling questions, uncertainty in

debt fight — July 27, 2011

Government Shutdown Begins as Deadlocked

Congress Flails — July 27, 2011

Strained State Officials Fear Effects of

a Federal Shutdown — April 6, 2011

The Unknown

Photo courtesy of Annysa Johnson/

Milwaukee Journal Sentinel/MCT

Photo by Tanner Christensen

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

1990

1991

1992

1992

1993

1994

1995

1995

1996

1997

1998

1998

1999

2000

2001

2001

2002

2003

2004

2004

2005

2006

2007

2007

2008

2009

2010

2010

20

11

2012

Unforeseeable Events Can Have Outsized Impacts

Source: State coincident index, Federal Reserve Bank of Philadelphia

U.S. Louisiana Hurricane Katrina

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

20

11

2012

Louisiana Economic Performance versus United States, 1990-2012 Year Over Year Growth

Complex Problems, Complex Causes

• Despite complexity, there are several common-sense approaches to managing state finances in the face of unavoidable volatility

• Many states already have policies in place that work to hedge volatility and budget risk that could be strengthened or improved

What States Can Do

Understanding Volatility

CHALLENGE

SOLUTION

States often lack information about what drives revenue volatility and those factors change over time

States should study their unique sources and drivers of revenue volatility

Study Sources of Revenue Volatility

Utah’s Joint Revenue Volatility Report

Communicate the Possibilities

CHALLENGE

SOLUTION

States will never be certain exactly how much revenue they will receive in any given year, which complicates the budget process

States may be able to improve the accuracy of their revenue forecasts by timing them closer to the final passage of the state budget

Most Accurate Revenue Forecasts are Done Close to Budget Enactment

AR

AZ

CA

KS

MD LA

MI ME DE

MN NC HI

IA ND AK NE IL

ID OK CO NH NY

GA MO SC FL NJ OH

TX NM SD IN NV PA

AL VA VT UT KY OR RI

MT WV WY WA MS WI TN

31 to 35 26 to 30 21 to 25 16 to 20 11 to 15 6 to 10 1 to 5

Preliminary data on number of weeks the forecast is completed prior to the start of the fiscal year

Start of Fiscal Year

Source: Pew and Rockefeller Institute analysis of survey of state forecasting officials..

Counter the Cycle

CHALLENGE

SOLUTION

Revenue volatility causes extensive year-to-year variation in the resources available to state governments

States should redesign their reserve funds to smooth budgets across the business cycle

Counter the Cycle Virginia

Brenna Erford

berford@pewtrusts.org

pewstates.org/fiscal-health