Use Dynamic Analysis in Revenue Estimation

Dynamic analysis is an attempt to measure the full impact of fiscal policy revisions, including tax proposals, on revenue estimates. It can also provide legislators with more information when considering fiscal proposals.

One example is the 2008 increase in the severance tax. The state revenue estimate was based on an $8 natural gas futures contract price on the NYMEX. But a study by the Univ. of Arkansas Center for Business and Economic Research cited an average $6.21 price for forecast investments to occur, and the contract currently trades at a much lower price, less than $4.

Dynamic analysis has evolved from theoretical to practical since the Policy Foundation first recommended the idea in 1998. The American Economics Association and National Bureau of Economic Research have published papers on the issue in the last decade. Arkansas is able to conduct dynamic analysis of major fiscal policy proposals. The state has access to trained experts and an econometric model that attempts to measure dynamic effects of policy changes at the level of the national (U.S.) economy. This should also be applied to the state (Arkansas) level.

Legislators have recognized tax rates affect individual economic behavior by crafting a border city exemption for citizens of Texarkana, which borders a state (Texas) that does not levy an individual income tax. Measuring individuals' behavioral response to tax rate revisions is an important part of dynamic analysis.

A common question posed by legislators and citizens they represent is, ‘What is the impact of tax proposals on state revenues?' Subjecting fiscal proposals to dynamic analysis will give them more information. One important detail: If this analysis is used the non-commercial methods used to develop revenue estimates should be transparent and subject to disclosure under the Arkansas Freedom of Information Act so the public interest is protected. This includes assumptions about variables used in the analysis.

Recommendations

· Legislators should be provided with a second severance tax revenue estimate based on a lower natural gas futures contract price.

· Dynamic analysis should be used in revenue estimation for any major fiscal proposals including any reduction in the sales tax on groceries or income taxes including capital gains.