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California's Economists Frequently Are Wrong

State's unexpected revenue swings come in part from failure to forecast stock market.

January 14, 2003|Jeffrey L. Rabin | Times Staff Writer

Like weather forecasters who missed a devastating storm, economists in Sacramento have failed to accurately predict state tax revenues for years.

When the stock market boomed, the state reaped the benefit of a phenomenal increase in the wealth of upper-income Californians. Forecasters were caught by surprise when revenues exceeded their expectations by billions of dollars a year.

Then, when stock prices plunged, the state's fiscal fortunes nose-dived, confounding forecasters yet again.

"The economic forecasts haven't been all that bad, but the recent revenue forecasts have been off the mark," said Brad Williams, senior economist for the legislative analyst's office. "It has been very tough forecasting the unknowable, which is the stock market and what would arise out of the stock market."

That has played havoc with economic forecasts across the country, but it has had particularly serious effects in California, where the state budget relies heavily on income taxes, including income derived from capital gains made by stock market investors.

Moreover, few of those problems are directly addressed by the $96-billion budget that Gov. Gray Davis introduced last week. Although it relies somewhat more heavily on sales taxes, which are easier to forecast than income taxes, it also raises taxes on the wealthiest Californians, those whose income is most volatile and most linked to the fortunes of the stock market.

Davis' budget also is built on some assumptions that may not materialize, most notably its reliance on $1.5 billion from Indian gambling. That money will come to the state only if California tribes agree to pay state taxes in return for more gambling; if they don't, the revenue forecasts for next year will need to be revamped.

California's revenue predictions are the byproduct of a select group of economists, drawn from the public and private sectors. They start each fall with a prediction of growth in the U.S. economy. That forecast is then adapted for the California economy to produce estimates of personal income, jobs, taxable sales, bank and corporate income, housing construction and other factors.

"The pace of job growth and the pace of personal income are ultimately the drivers of the income tax estimate," said outgoing state Finance Director Tim Gage.

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Personal Income Is Key

Tom Lieser, senior economist for UCLA's Anderson Forecast, said the income numbers are more important than most elements in the forecast because the state relies so much on income tax to support government programs.

Each October, state forecasters put together a preliminary estimate of revenues likely to be available for the fiscal year that begins the next July.

In mid-November, the state Department of Finance meets privately with outside experts to discuss the economic outlook for the coming fiscal year.

That select group includes economists from universities and certain key industries such as high-tech, telecommunications and agriculture. But attendance at the annual event has dropped as major banks and utilities move their headquarters to other states or eliminate in-house economists.

When the experts got together in Sacramento last fall, the legislative analyst's office had just released its own economic forecast, predicting slower economic growth and weaker revenues.

Jack Kyser, chief economist for the Los Angeles County Economic Development Corp., said the mood at last fall's meeting could be summed up in one word: gloomy.

By early December, the respected Anderson Forecast from UCLA's business school also was painting a darker picture of the state economy's prospects.

Lieser said UCLA lowered its forecast because California's economy is now likely to sputter through the first half of this year. He predicted slower growth, higher taxes and reduced public services.

A week before Christmas, Davis stunned observers by announcing that the budget deficit had grown to $34.8 billion, far larger than any previous estimate.

The governor's estimate was far higher than the $21.1-billion gap reported by the legislative analyst's office only a month earlier. That figure was developed using different assumptions about revenues and spending.

Davis blamed half of the problem -- $17.7 billion -- on earlier revenue estimates that were too high. Of that, almost $12.4 billion of the reduction was because of lower projections of income tax receipts.

The gap between the revenue forecast made by the Davis administration last May and the one contained in the governor's budget released Friday is particularly noteworthy.

Last spring, the Department of Finance told lawmakers that income tax revenues would reach $40.5 billion in the coming fiscal year, the highest level since the stock market boom. But the administration abandoned that forecast recently, and now expects such revenues to reach only $33.6 billion, a decrease of $6.9 billion, or 17% in seven months. Projected revenues from sales taxes and bank and corporation taxes also dropped, by about 5%.

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