Forecasting for Local Government Budgets
The Challenges of Forecasting
This article on forecasting revenue is the second in a series that describes strategies and options regarding the budget process in local government in Michigan. Forecasting may provide what the future may look like from a revenue and expense perspective. Forecasting can provide some challenges including, but not limited to:
- Outlook Problem - How do we know what the future will look like?
- Information Problem – Do we have enough information to make a good forecast?
- Compromise Problem - What if we disagree about the priorities or even the definition of fiscal sustainability?
In addition to these challenges, the forecasting of revenue can be volatile. Consider the recent recession that began in 2009 and lasted for as much as six years before a slow recovery returned. Local governments were constrained by revenue volatility during this time and, generally speaking, are subject to mandated constraints by state government. One case in point is the Headlee Amendment that places significant limitations on the fiscal relationship between state and local units of government. Contrary to past experience, revenue does not grow in a straight line. If it did, it would be much easier to “forecast” revenue. Revenue volatility might be removed if revenue options move in different directions during a business cycle.
As local governments forecast revenue, they should determine how far in advance they want to look into the future (three, five, 10 or more years). Additionally, identifying domains that are more easily assessed can be helpful. Some of these include: A) Pensions and retiree health care costs, B) Economic conditions albeit volatile, but the past could provide some indication of the future and, C) Spending may be easier using population and inflation as drivers.
When a local government chooses to use forecasting as an instrument relative to budgeting, they should keep in mind that any good forecast has a “range” around which the true values are likely to occur. For this reason, it might wise to consider the exploration of several scenarios rather than one “forecast”. Additionally, the further out a forecast projects the less accurate it can become.
Future articles in this series will discuss, compromise and community engagement and communications as functions of the local government budget process.