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Tuesday, January 17, 2017

CREG Report: Intentional Over-Optimism

The Consensus Revenue Estimating Group has released its January report. Once again, I am sad to say that their report is tainted with deliberate over-optimism. I do not say this lightly, but there is far too much evidence in their reports - not just this one, but similar reports from years back - that is impossible to ignore. 

Let us begin from the beginning. The main message in this report is that:
investment income from the Pooled Account, the Permanent Wyoming Mineral Trust Fund (PWMTF) and Common School Permanent Land Fund (CSPLF) throughout the forecast period; the sales and use tax forecast throughout the forecast period; assessed valuation ratio for natural gas; the coal price estimates; and coal production estimates for calendar year (CY) 2017 and CY 2018. The forecast also revises coal lease bonus payments for FY 2017 and FY 2018 to incorporate updated sequestration payments. All other revenue streams and assumptions remain unchanged. 
There is a pattern in how CREG adjusts its numbers, and reports its findings, that points strictly toward deliberate over-optimism. As always with CREG, the main adjustments in their reports are in the forecasts themselves. Those adjustments are based on the discrepancy between the actual performance of the economy and the predictions of that performance as CREG made them in the past. 

As I explained in October, practically every forecasting adjustment that CREG makes is for the worse. In plain English: there comes a point where they have to set aside their chronic over-optimism and concede to reality.

This is once again the case. Back in October, CREG predicted that sales tax revenue for the 2017-18 biennium would amount to $833 million; in their January forecast they adjust that number downward to $825 million. However, this downward adjustment is not given much attention in the report. Instead, they place the spotlight on a $17.4-million upward adjustment of predicted severance tax revenue:
CREG revised severance tax projections upward to reflect the recent positive momentum in coal production and updated assessed valuation as a percentage of gross value for natural gas to match current trends. These revisions increased the estimated FY 2017-2018 biennium severance tax distribution to the GF and Budget Reserve Account (BRA) by $17.4 million. Legislative action during the 2016 Budget Session (2016 Wyoming Session Laws, Chapter 31, Section 325) diverted an amount equal to a one percent severance tax from the PWMTF to a separate One Percent Severance Tax Account. The revised severance tax assumptions increased the estimated distribution into this account for FY 2017-2018 biennium by $4.8 million when compared to the October forecast. 
Of the two taxes - sales and severance - the former is far more important as an indicator of how our state economy is doing. A decline in actual sales-tax revenue, which has prompted the downward adjustment in the CREG report, is a strong indicator that our state's economy is doing just as bad as I have been reporting on. 

Furthermore, CREG itself admits that the part of the sales-tax revenue that the minerals industry is responsible for, has shown marginal improvement in recent months. With this in mind, it is even more conspicuous that CREG continues to say that by and large, the revenue outlook is always upward. Once again, they deliberately avoid reporting economic facts that contradict their unending desire to present a positive revenue trend. 

As for "momentum" in coal production, I have explained in previous blog articles why the decline in coal is tapering off. When an industry suffers a sharp decline in demand for its products, it goes through an adjustment period when production, employment and cash flow are all reduced to comply with the new situation. Unless demand is completely wiped out - as it was for typewriters when the personal computer became middle-class affordable - the adjustment period will end once the decline meets the new, lower level of demand. 

There are indications that our coal industry has reached that point, one of them being the employment situation: the coal industry appears to have a workforce adequate for a new, lower, long-term sales level. 

The fact that the coal industry is leveling off does not mean it is going to start climbing back. For this reason, it is wrong to talk about a new "momentum"; a new "normal" or new "stability" would be far more appropriate.

An analytical error on this point has significant consequences. If we assume that the end to the decline in coal production is sign of a new momentum, then we will by default predict rising tax revenue in the near future. This is exactly what CREG has done. If, on the other hand, we understand this as an end to the decline in coal production, then our default forecast will be that tax revenue will stabilize - but not increase. 

Once again, CREG chooses to analyze the situation in such a way that it improves the state's tax-revenue outlook. Given how notoriously over-optimistic they have been in the past, I am not surprised that they once again set themselves up to be proven wrong in yet another one of their forecasts. There is, however, a big problem with how they go about their forecasting: because of their chronic over-optimism, our legislators - who in many cases take CREG reports as economic gospel - adopt the same rosy outlook on our state's future. When they do, they fail to identify, understand and solve our state's major macroeconomic problems.

To be blunt: CREG disregards the macroeconomic context within which our state government operates. If you do that, you automatically assume that the state government is somehow independent of how the rest of the economy performs. A good indicator of this default assumption - in addition to their chronic over-optimism - is their brief comment on the sales tax:
Despite improving rig counts, the number of oil and gas jobs in Wyoming has remained essentially unchanged from October 2016 levels through the end of December 2016. Moving forward CREG revised projected sales and use collections upward based on expected modest improvements in commodity markets and those industries related directly and indirectly to mining. Additionally, statewide sales and use tax collections are running behind October 2016 CREG expectations. 
The only recognition of the non-minerals part of the Wyoming economy is that last sentence. Almost like an afterthought, they acknowledge the part of the economy that produces at least two thirds of all sales and use tax revenue. Since that part happens to be in about as big of a decline as the minerals industry has been in the past year and a half, the case for a rosy forecast of state tax revenue is rather weak. 

To further highlight the over-optimism in CREG's reporting - or, to be more precise, in how they present their forecasts - they essentially ignore the big revenue tumble that is reported in their own numbers. Table 1, on page 2 in the report, looks like this, in summary:

Table A
Predicted Tax Revenue
2017-18 Biennium
In Oct 2016 In Jan 2017
Total tax revenue*  $2,836.60  $2,837.40
Predicted Tax Revenue
2019-20 Biennium
In Oct 2016 In Jan 2017
Total tax revenue* $2,577.10 $2,569.90
Predicted revenue decline -$259.50 -$267.50
-9.15% -9.43%

As these numbers show, CREG predicts a decline in revenue by more than nine percent from the current biennium to the next. The predicted decline has increased since October, admittedly by a small margin, but nevertheless. Given the attention that CREG gives every slice of good news - merited or not - it would only have been fair of them to at least notice the widening revenue decline from now through 2020. 

That said, it is not so much the numbers behind the revenue decline that are a matter of concern, but the continuous trend of declining revenue. In January 2016 they predicted $2,894.6 million in total tax revenue, but that was only for the General Fund and for the Budget Reserve Account. Since then, the one-percent Severance Tax Account has added further revenue to the "total" revenue bucket, and the revenue trend is still negative. 

As further illustration of this point, consider how the January CREG reports have altered their outlook just on General Fund revenue (see Table 2 in respective year's CREG report):

Table B
For Biennium
2017-18 2019-20
Forecast made January 2015 $2,301 $2,408
(millions of $) January 2016 $2,084 $2,161
January 2017 $1,946 $1,968

Every year they adjust their forecast downward for each biennium (up-down in the table), yet the same forecast still predicts that revenue will increase from one biennium to the next (left-right).

In other words: yet more evidence that CREG forecasts are chronically over-optimistic. With this pattern, I am going to go as far as to say that their over-optimism is deliberate.

There is more to say about this CREG report, but it requires an elaborate macroeconomic background. Stay tuned for updates.
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*) In this context, "total tax revenue" means revenue for the General Fund, the Budget Reserve Account and the one-percent Severance Tax Account. 

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