Don’t put much stock in surplus predictions
Connecticut’s Office of Policy and Management (OPM) and its Office of Fiscal Analysis (OFA) both released fiscal accountability reports on Nov. 18 forecasting annual fiscal surpluses through fiscal year 2026.
While these reports are legally mandated to be issued in November, they are exercises in virtual futility at this time of year, especially this year. Why? Because one of the largest sources of revenue and the largest category of expense involve significant unknowns even for the current fiscal year ending June 30, 2023.
Revenue from taxes on investment income is highly variable and unpredictable. Indeed, state law labels it officially as “volatile.”
State employee compensation expense, including wages, pensions and health care expenses is the largest category of expense. This year, pension and retiree health care expenses are largely unknowns after triple the normal number of employees retired last fiscal year; estimating retirement obligations is largely the responsibility of the state’s outside actuaries, who have not yet submitted their updated valuation reports.
The OPM and OFA reports would be much more valuable if issued in January, when the actuaries’ valuation reports are in hand and the stock market outcome is final, and investors have filed mid-January quarterly tax filings, including payments supposed to bring their cumulative quarterly payments up to their full-year obligation.
This fiscal year has seen a reversal of fortune that illustrates dramatically the volatility of this revenue source. Last fiscal year, this revenue surged to $6.5 billion, overshooting the budget by 44% and reaching 26% of total revenue, on the strength of a soaring stock market. The S&P gained 25% and the technology-heavy NASDAQ advanced 35% in 2021.
In contrast, so far in 2022, the S&P is down 15% and the NASDAQ is down 27%. Yet we won’t know the final outcome until January.
So much for the recommended delay in the timing of the OPM and OFA reports.
Now to the substance of the actual reports just released.
While we do not know yet the final outcome in the stock market, we can agree that it is highly unlikely that the market will regain in one month the large losses it has sustained in the prior 11 months.
On average, there can be gains only if the stock market is up for the year. If the stock market were up but not as much as previously, that would imply smaller gains and lesser tax revenue from those reduced gains.
Yet, 2022 is producing big losses, not lesser gains. It is not unreasonable to predict at least a 50% decline in taxes on investment income, which will likely be comprised only of dividend and interest income.
Yet, that is not the prediction in the OPM and OFA reports. Back last April when the fiscal 2023 budget was adopted, a decline of only 15% was budgeted for this revenue. Why aren’t OPM and OFA revising the budget lower after seven months of market declines?
When I asked OPM this question back in late September, the OPM spokesman replied “the state is virtually on target with what we received in September last year.”
The problem with this explanation is that most of this type of revenue is realized in January through April and beyond. Indeed, OPM’s own report says “Almost 40% of total collections are received in April when final tax returns are filed…”
Accordingly, being on target through September or mid-November is virtually meaningless. Take fiscal 2022. In April 2021, the budget for this type of revenue for fiscal 2022 was set at $4.5 billion. Even as the stock market soared in the following months, OPM did not revise the budget. Only twelve months later on April 20, 2022, did it increase the estimate by $900 million to $5.4 billion. Twelve days later it increased it another $800 million to $6.2 billion.
Evidently, OPM did not want to make a considered judgment and change the 2022 budget until it absolutely had to. And the same thing is happening this year. This may be unchangeable risk-averse bureaucratic behavior. So, delaying the timing of the fiscal accountability reports may not help. OPM did not change its forecast last January based upon last January’s quarterly estimated tax filings, which had to have reflected much of the robust gains ultimately realized last year.
Alternatively, the process could be improved by greater transparency. Monthly revenue figures by revenue category could be released, enabling private sector analysts to make prompter revisions than OPM and OFA. In fact, the State Comptroller’s Office does publish such numbers, except that, this year, it hasn’t released any monthly numbers since last May.
The bottom line is that no one should take the projections in the OPM and OFA fiscal accountability reports too seriously. Almost certainly, their projections of tax revenue from investment income for the current fiscal year (FY2023) are way too high. If so, likely there will be a cascade effect, throwing off predictions for later years.