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Betting on the Future with a Cloudy Crystal Ball? How Financial Theory Can Improve Revenue Forecasting and Budgets in the States

Authors


Fred Thompson is the Grace and Elmer Goudy Professor of Public Management and Policy and Bruce L. Gates is a professor of quantitative methods and public management in the Atkinson Graduate School of Management at Willamette University in Salem, Oregon. Both are former members of PAR’s editorial board. Professor Thompson recently served on the United Nations Development Program’s Blue Ribbon Commission on Macedonia and helped author its report Achieving Dynamic Economic Growth. In 2005, he received the Association for Budgeting and Financial Management’s prestigious Aaron Wildavsky Award for lifetime contributions to public budgeting and financial management.
E-mail: fthompso@willamette.edu, bgates@willamette.edu

Abstract

Accurately predicting revenue growth is nearly impossible. Predicting the peaks and valleys of the business cycle is even more hopeless. This matters because tax revenues are largely driven by economic growth. Volatile, unpredictable revenue growth causes all sorts of unpleasant responses on the part of governments, most commonly manic-depressive patterns of spending and taxing. Fortunately, modern financial economics gives us a set of tools that can be used to manage volatility. This article shows how such tools can be used to inform fiscal decision making. The focus here is state governments, but the analysis applies to all jurisdictions that face hard budget constraints and therefore must balance spending increases against revenue growth.

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