Monday, May 7, 2018

Don't Misread Latest CREG Report

On April 27, the Consensus Revenue Estimating Group released its revenue update for the first quarter of 2018. The report was a source of joy to some, and will most likely embolden the tax-and-spenders in the legislature. 

That would be bad, of course. The state budget is still in the red, and the trend is still one of growing deficits, not shrinking ones. Furthermore, for three reasons the bump in revenue is of such a weak quality that the most prudent approach for our legislators would be to ignore it and continue as if the deficit is still growing (which, again, it is). 

First, as I have explained abundantly on this blog, last spring the Wyoming economy came out of its steep decline and entered a state of stability. That does not mean that we will enter some kind of rebound phase. Absolutely not - that is now how the economy works. All it means is that the end of the downturn meant the beginning of a new normal at a lower state of macroeconomic activity. That has now happened, and it means that tax revenue will no longer tailspin - they will essentially stay leveled.

Secondly, the improvements in tax revenue that the CREG report presents, are largely related to the Trump bump in the national economy. There are no internal, Wyoming-specific reasons for tax revenue to go up. On the personal income tax side, the Trump tax reform left more money in the pockets of consumers across the country; on the corporate side, the substantial cuts in the corporate income tax emboldened many employers to increase pay. Taken together, the personal and corporate tax cuts have therefore led to a spending increase that, already now, is showing up in state tax coffers. 

The Wall Street Journal notes this (Monday May 7, print edition):
State budget officials from Utah to Connecticut are reporting higher tax revenue and a brighter fiscal outlook, thanks to an improved national economy and robust job growth. ... Taxes on income and sales are both coming in higher than expected, reflecting factors such as rising employment ... The effects of the new federal tax law also boosted state revenue, though analysts caution it will prove temporary for many states that are benefiting from sped-up tax payments. But state officials say they see evidence of underlying improvement too.
That underlying improvement, again, is the improved macroeconomic activity following the Trump tax reform. The nature of that reform is such that the improvement will be temporary; when we have exceeded three percent in GDP growth for a year; when the growth effect wears off; we will be left with the same-old two-or-so percent growth economy that we have become used to since the turn of the Millennium. 

When that happens, most of the boost in our state's tax revenue will wither away.

The third reason why our legislators should ignore the modest revenue boost is that it is a boost over the previous forecast. Here is basically what that means in practice. On Monday I predict that on Wednesday, the top mid-day temperature is going to be 72F. On Tuesday I change my forecast to 74F. 

Has the weather gotten warmer on Wednesday?

The comparison to state revenue forecasts is not perfect, as the revenue forecast relies on a stream of actual economic data up to the point of the forecast. However, just because that revenue is higher than they thought it was going to be, does not mean that the increase in revenue represents an actual improvement in economic activity. 

This is not a problem that is isolated to CREG's forecasts. It is a problem in all economic forecasting, especially that which is based on econometrics. The problem lies in how we interpret its results, and - again - that is where the risk lies: our lawmakers could easily run amok and decide that there is no longer any need for structural reforms to spending. 

To his credit, in the Gillette News Record article quoted above, Senate President Bebout does give voice to this caution. Unfortunately, there is a significant risk that come the 2019 session, we will be dealing with a legislature that is notably farther to the left - and more prone to tax and spend.

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