A significant factor in constructing a state budget hinges on the precision of its fiscal predictions: estimating tax revenues intended to finance services for the upcoming year. Since 2001, the accuracy of these forecasts has suffered due to increased volatility in revenue streams, including significant fluctuations in personal income and consumer expenditures. Forecasting errors can lead states to unnecessarily cut spending, increase taxes, postpone essential projects, and implement other changes impacting millions of citizens.
Recent research from Texas McCombs has introduced a method that could significantly enhance the precision of fiscal predictions: tracking the earnings growth of publicly traded, tax-paying corporations. Braden Williams, associate professor at Texas McCombs, co-authored the research with Lillian Mills, dean and professor of accounting at McCombs, and Anthony Welsch from the University of Chicago. They suggest that corporate earnings are a crucial yet underutilized resource for revenue forecasting. Traditionally, states rely on past revenue data and macroeconomic indicators like GDP and unemployment rates, with teams composed chiefly of economists and statisticians but lacking in accounting expertise.
To assess the potential impact of corporate earnings data on revenue forecasting accuracy, the researchers evaluated the combined earnings growth of major industries in the U.S., such as mining, gas, technology, financial services, and healthcare. They correlated this data with the industries’ presence in each state to create a tailored earnings growth metric for each state. They then retrospectively applied this metric to past forecasts to simulate the potential improvements it could have made, finding that including corporate earnings data significantly enhanced forecast accuracy. By including these figures alongside traditional economic metrics, the researchers could explain up to 86% more variation in actual revenue figures.
This approach was efficient in states with diverse industries. States with fewer dominant industries, like Wyoming’s oil sector, already needed more data. However, the earnings growth measure proved particularly useful in states with a balanced mix of industries. Including corporate earnings didn’t just enhance the forecasting of corporate tax revenue but also improved predictions for sales and personal income taxes. Notably, the improvement in individual income tax forecasts was even more significant in monetary terms than corporate taxes.
The study highlighted several ways corporate earnings growth influences other tax revenues: portions of corporate profits are returned to owners as capital gains or dividends, earnings growth can affect wage growth if companies share profits with employees, and business investments and purchases show up in sales taxes. Corporate earnings data can help states avoid mid-year budget cuts by providing a more accurate initial forecast.
The research from Texas McCombs suggests that while traditional economic indicators are valuable, the integration of specific, detailed corporate data can significantly refine fiscal predictions. This not only aids in more accurate budget planning but also plays a crucial role in preventing the socioeconomic disruptions caused by budgetary adjustments during the fiscal year. By providing a more accurate initial forecast, the use of corporate earnings data can help states avoid mid-year budget cuts, thereby ensuring a more stable and predictable financial environment for citizens.
More information: Anthony Welsch et al, Do accounting earnings provide useful information for state tax revenue forecasts? Review of Accounting Studies. DOI: 10.1007/s11142-024-09840-w
Journal information: Review of Accounting Studies Provided by The University of Texas at Austin