Revenue forecast won't be pretty

  • Article by: MIKE MEYERS , Star Tribune
  • Updated: November 29, 2008 - 11:45 PM

This week’s state revenue forecast will show streams of revenue falling further and faster than at any time in recent memory.

More than 40 times over the past 21 years, Minnesota state economist Tom Stinson and his team have sat down to estimate how much money the state will collect to spend on education, bridge building and other services.

In the past few weeks, with state, national and international economies reeling, their job has been more like exploring the force of gravity.

Outlook for sales tax revenues: falling.

Projections for tax collections on wages: falling.

Taxes from car and home sales? Executive bonuses? Corporate profits? Falling, falling and falling.

The latest state revenue forecast, to be unveiled on Thursday, means legislators will face an especially grim task this year as they work to balance the state budget. The forecast that guides them will show streams of revenue falling further and faster than ever before in the memory of Stinson's team, some of whom have been on the job since the 1970s.

Last February, Stinson's group projected a $935 million budget deficit for the current biennium, which ends June 30, 2009. The Star Tribune agreed to keep the figures from the latest reading confidential, but budget forecasters anticipate public reaction to this week's forecast in one word: "Shock."

"Sometimes the forecast is pretty boring," Stinson said. "Not this time."

The team started drilling into the numbers in early November, after weeks of carefully monitoring state economic statistics on everything from employment to sales tax receipts. The hours got longer after they sifted through the national economic forecast generated by Global Insight, a leading consulting firm commissioned by the state.

In the weeks leading up to Thanksgiving, days turned into nights as the team checked and rechecked statistics.

Every change in computer models used in the forecast was logged. By late November, the changes numbered more than 100.

As Thanksgiving week approached, the team polished off leftover Halloween candy from home to keep up their energy in sessions stretching past midnight.

In addition to Stinson, the team includes a number of veterans, staff economists Patrick Meagher and John Peloquin, as well as Joe Gervais, research scientist. Staff economist Matthew Schoeppner recently joined in. A Star Tribune reporter sat in on many hours of the revenue estimate sessions -- a period when economists and statistical gurus in the Minnesota Department of Finance routinely put in two weeks' worth of work in one week as the deadline looms.

Time after time, the state finance experts looked at computer projections of revenue declines and asked each other, "Could this be true?"

Over and over again, Stinson repeated the same word: "Ugly."

"You're hoping to find technical reasons to add more revenue," Stinson said. "Instead, all of the rocks you turn over bring you bad news."

While revenue forecasting always is more art than science, the rapid deterioration in both the U.S. and world economies made the process especially difficult. The state team began with the freshest forecast from Global Insight, a consulting firm outside Boston that has more than 5,000 clients, many of them state and local governments. What they found mostly were ill winds.

Almost every measure of the U.S. economy's outlook -- employment, incomes, construction, retail sales, corporate profits -- had slid since Global Insight's October forecast. Within days of receiving that bleak report, Stinson and his team listened in on a webcast the firm held for its clients. The message: The November forecast probably was too optimistic.

Things were changing fast. The financial crisis had the U.S. Treasury Department and the Federal Reserve burning midnight oil -- and hundreds of billions in cash -- to rescue the economy, but their efforts generated no signs of a turnaround, Global Insight said.

As the finance department experts sifted through piles of charts and graphs, they noticed something they hadn't seen before. None had an "optimistic" scenario for the U.S. economy.

State forecasters took the hint. No need to consider the upside in a large array of economic activities.

When Nariman Behravesh, Global's chief economist, heard that observation by Stinson and his colleagues, he laughed, offering a touch of black humor.

"The optimistic forecasts exist," Behravesh said. "It's just that the optimistic forecast is for a mild recession."

At last reckoning, Global Insight gave 60 percent odds for a garden-variety recession like that of 1990-91, which cost about 840,000 jobs nationwide. The consulting firm gave 25 percent odds on a recession like that of 1981-1982, when more than 2.5 million jobs disappeared. But the probability of that harder recession is rising.

Count and recount

Minnesota's economists have a record of predicting tax collections accurately much of the time, but the thousands of pieces of data and the scores of formulas make measuring turning points difficult, Peloquin said.

The attention to detail is almost unimaginable.

One Friday night, the income-tax model projected a decline in state tax liability in 2008 compared to 2007, not a more typical slowdown in growth.

"To see it actually fall raises a whole lot of concerns," Stinson said.

To double-check, the team laboriously went through more than 300 lines of data.

They found a glitch, but not one related to the income-tax question. Fixing that problem had the team up until 1:30 a.m. With billions of tax dollars and hundreds of state programs in the balance with every revenue forecast, Meagher calls examining minute details an effort to "show due diligence at our trial."

The glitch fixed, the income tax estimate remained unchanged -- dropping.

"It appears to be true," Peloquin said.

Nevertheless, he and other forecasters are humble about their computer models. "This is like pointing at a map with a two-by-four," he said.

Consider the sales tax. The forecasters must pore over more than 40 components -- taxes on sales of eating and drinking establishments, software companies, pet grooming parlors, auto parts dealers, dry cleaners, liquor stores, construction materials and on and on.

"We can observe long after the fact how much was sold, but not what was sold," Peloquin said.

For instance, retailers like Home Depot offer up an umbrella number for sales that includes everything from roofing nails and drywall to soft drinks and candy.

But housing starts and building permits, along with national economic forecasts, give researchers a rough but good idea of what to expect on key sales-tax components. Peloquin said the computer model suggests Minnesota sales of construction materials won't return to 2005 levels until 2012.

Uncharted seas

Schoeppner noted that, whether in the case of incomes and bonuses, retail sales or demand for business services, the view ahead is particularly cloudy given the fact that many businesses are reporting unprecedented troubles.

"Best Buy comes around and says this is the worst retail environment they've ever seen," Schoeppner said.

Consider the "wealth effect" associated with the value of houses. When house values climbed 20 percent over four or five years, consumer spending climbed. Now that house values are falling will consumer spending fall at the same pace it once rose?

No one knows.

"We're outside the bounds of things that we would normally use to give us some idea of whether the projections are reasonable or not," Stinson said.

Adding to the complexity of the forecast is the fact that the Minnesota job market was growing more slowly than the national pace before the current slump began. Does that mean the state has fewer jobs to lose because employers were cautious in hiring?

Again, no one knows.

"Our growth lately has not been stellar. Instead of wrecking a brand new car, we're wrecking a jalopy," Meagher said.

The timing of economic decisions by millions of different people also can confound the forecast.

President-elect Barack Obama has talked of raising the capital gains tax. Would that encourage people to sell stock sooner rather than later, beating the tax increase? Or will the plunging price of stocks this year mean that fewer people will cash out their holdings, preferring to hang on and pray for a rebound?

In the vernacular of budget watchers, Minnesota' economy appears to be starting from a lower base -- that is, underperforming the nation -- and it's likely to grow more slowly from that lower level once growth returns.

"So it's the worst of all worlds," Stinson said.

Mike Meyers • 612-673-1746

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