Does our way of forecasting shortchange our future? 

Creating and approving the Arkansas state budget is demanding work for our governor and legislature. Predicting how much money the state will bring in from fees and taxes is both science and art. In recent years, the executive branch has consistently underestimated this incoming revenue. This in turn has led to annual budgets that invest less than they may have in programs and services that are important to the economic and social vitality of our families, communities, and the state.  

According to Arkansas law, the chief fiscal officer of the state must provide by the middle of May the official forecast of general revenue available for the upcoming fiscal year. This year’s forecast memorandum, from the Secretary of the Department of Finance and Administration to the Arkansas Legislature, was sent on May 15, 2024. 

The Department of Finance and Administration employs the Chief State Economist, responsible for generating the general revenue forecast. The forecaster collects data and creates models to analyze past trends to predict the future. But the economist must also make significant assumptions. For example, will inflation increase or decrease? Will consumers spend more or less? Will the labor market and wages expand or contract? What is the effect of repeated rounds of income tax cuts? Tax collections, especially corporate income tax collections, are quite volatile. Forecasting is tough work. 

During the past five complete fiscal years, net general revenue projections – the prediction of how much the state would receive from fees and taxes – have consistently been lower than actual net general revenue received (for a total of $4.66 billion): 

Net General Revenue Forecasts vs. Actual Net General Revenue Collections (in $billions) 

Fiscal Year	May Forecast	Actual Revenue	Difference
2024	6.622	6.900	0.278
2023	6.114	7.185	1.071
2022	5.687	7.477	1.790
2021	5.384	6.845	1.461
2020	5.690	5.753	0.063

There are various explanations for these differences beyond the difficulty of forecasting, most notably a conservative approach to estimating revenue. There is nothing wrong with conservative forecasting. Indeed, one might argue that a conservative approach to forecasting revenue is preferred to prevent an approved budget that we cannot afford because predicted revenue doesn’t materialize. And to be fair, the Department of Finance and Administration provides monthly updates to the official forecast (for many of these, monthly collections also beat monthly projections). 

Importantly, Arkansas has two policy instruments in place to ensure the budget is balanced. The Revenue Stabilization Act, which is amended every year as the official budget of the state, creates various “buckets” of spending priorities. Those programs and services that must be funded are placed in the first bucket, and any subsequent buckets have decreasing priority. If, during a fiscal year, revenue lags the forecast, the state does not fund the programs and services in the lowest-priority bucket or buckets. 

Second, the Arkansas Legislature has created a series of reserve funds to hedge against any economic downturns. The most notable of these is the “Catastrophic Reserve Fund,” which can only be accessed if there is a shortfall in revenue collection. This fund contains about $1.5 billion and accrues interest over time. Takend together, the Revenue Stabilization Act and reserve funds are effective tools to prevent deficit spending and balance the budget. 

Forecasts that underestimate revenue can lead to budgets that do not strategically invest in policies that support all Arkansans. For example, if legislators knew that the state would have an additional $1 billion or more in revenue (as happened in FY21, 22, and 23), they could have expanded access to quality early childhood education and Pre-K programs. They could create services to alleviate the state’s maternal mortality crisis. And they could invest in policies to make housing more affordable. 

The “extra cash” – the difference between forecast and actual collection – makes it easier for some to justify additional income tax cuts. Instead of shortchanging our future through any additional reductions to revenue, the General Assembly, with the protection of the Revenue Stabilization Act and reserve funds, not to mention our consistent record of coming in under budget, should strategically invest these additional funds in policies to help all Arkansas families.