State tax revenue instability and contingency funds (forecasting)
Description
During the past twenty years, states have come to rely on taxes that exhibit a high degree of instability or variation in their yields, while budget policies are constrained by legal restrictions. The problems generated by tax revenue instability and these legal restrictions have led to undesirable tax and spending policies in response to unbalanced budgets. Recently, politicians and economists have been exploring and experimenting with various solutions so that these undesirable budget policies can be avoided The opening chapter provides a succinct description of tax revenue stability and a summary of the stability measures for each major tax source. Chapter 2 addresses the specific econometric issues in measuring stability and short run forecasting of tax revenues. The reasons for changing tax structures and legal restrictions on budget policies are examined. The recent behavior of state policy makers in response to deficits is then documented. We argue that, because of the instability of and restrictions on state fiscal systems, the observed adjustment behavior has not been as efficient as it could. In Chapter 3 we present potential solutions for problems associated with state fiscal structures. These solutions include stressing the recent use of contingency policies, is the contingency fund The contingency fund allows monies to be set aside during good economic times, and are available in the future when poor economic conditions prevail. While the current design of contingency funds appear to have been based on an arbitrary set of rules and consider political rather than economic criteria, it is possible to design an efficient fund based on economic principles. Two separate issues are involved for solving a problem of this nature: measuring the uncertainty and deriving an optimal forecast of tax revenues. We show that the solution is of a form such that the Kuhn-Tucker conditions are both necessary and sufficient for an interior optimal solution. In addition, the discounted multiperiod social welfare function is shown to increase with the contingency fund. Combining our solution with our measures of uncertainty, we perform a sensitivity analysis on the various parameters of the model and estimate their effect on the optimal contingency fund. As we expected, the size of the contingency fund grows as the degree of uncertainty rises. (Abstract shortened with permission of author.)