The business economist at work: the economics function at the Colorado Legislative Council

Business Economics, Jan, 1992 by Nancy J. McCallin

The Economics Department of the

Colorado Legislative Council is a nonpartisan

research group. Its chief function is to

provide the General Assembly with reliable

revenue forecasts used to prepare the state

budget, which is the responsibility of the

legislature rather than the Governor. The

economics staff also conducts research

relating to various tax and legislative issues.

THE PRIMARY function of the Economics Department at the Legislative Council is to provide the General Assembly with quarterly revenue forecasts, analyze and forecast the national and Colorado economics, and evaluate legislative revenue and budget issues. The Legislative Council of the Colorado General Assembly is a nonpartisan research agency that provides information to the Legislature.

REVENUE ESTIMATING

As is the case with most states, Colorado's constitution requires the state's budget to be balanced. Given this requirement, it is necessary to estimate the amount of revenue available for funding state government operations. Colorado is different than many states insofar as the General Assembly writes the budget and decides upon the levels of program by program appropriations. In most states this responsibility lies with the Governor. As a result of the role the Legislature plays in the budget process, the General Assembly needs a comprehensive, reliable forecast of revenues. Furthermore, it is important to be as accurate as possible in estimating revenues. A 1 percent error in the revenue forecast is equivalent to $27 million. The economics profession's standard 5 percent error is equivalent to $135 million of our General Fund (operating budget), clearly an unacceptable error rate. Even a 1 percent error rate is pushing the tolerance of policy makers, as $27 million is equivalent to funding either the Colorado Department of Revenue or the Colorado Department of Health.

If revenues are underestimated, this causes programs to be underfunded or not funded at all, thus depriving citizens of potentially necessary services. Meanwhile, if revenues are overestimated, this causes a budgetary shortfall, necessitating budget cuts, tax increases, or a reduction in the reserve set aside for revenue fluctuations. Increasingly, however, the reserve is being used for overexpenditures, especially for spiralling Medicaid costs; thus, one can no longer count on the reserve to bail out an overly optimistic revenue forecast. This leaves budget cuts and/or tax increases as the remedies for overestimated revenues, both of which are unpopular options for policy makers.

In order to produce the revenue forecast, a national forecast must first be compiled. In spite of the publicity given to Colorado's "energy boom" in the late 1970s and early 1980s, the state's economy is very sensitive to the national business cycle. Colorado, however, does experience somewhat of a muted business cycle compared with the nation. When the nation goes into recession typically the nationwide work force shrinks, whereas in Colorado job growth merely slows. Meanwhile, during national expansions, the state's job growth usually far exceeds nationwide gains. Once a national forecast is formulated, then a forecast of Colorado's economy is produced. We use several econometric models to produce the state's forecast.

After the statewide forecast is developed, we prepare forecasts of tax revenues by tax source. The bulk, 55 percent, of Colorado's General Fund revenues is derived from the individual income tax; 34 percent comes from excise taxes; and 4 percent is obtained from the corporate income tax. The remainder of the General Fund revenues is comprised of miscellaneous taxes, such as estate taxes, insurance taxes, and court receipts.

Prior to modelling these revenues, it is important to adjust the data for law changes where possible. Throughout the years, there have been significant law changes affecting even the smallest of revenue sources. Some law changes are fairly easy to take into account, such as a change in the tax rate or a change in the distribution formula that affects the amount of revenue received. Others, however, are less clear cut. For instance, Colorado's definition of taxable income for individual income tax purposes follows the federal tax code with some minor modifications. The 1986 Tax Act broadened the federal taxable income base. It is very difficult to ascertain how the base broadening affected income taxes in the state because Colorado's tax form is simplified to the point of providing almost no information regarding the tax base. We can only gain this information from federal tax tapes, which are available with a lag. For instance, we recently obtained federal tax data for 1988. In the case of corporate income taxes, businesses are allowed to carry forward losses for fifteen years and can amend their taxes for previous years as well. Disaggregating the data, however, to distinguish corporate tax liability adjusted for these carry forwards and amendments is not possible, given the way in which the data are collected. Hence, problems of data consistency are always a factor in revenue forecasting.