The role of revenue structure in the occurrence of rebudgeting

The budget document is the culmination of both a technical and political process. As revenues flow in, a variance is created causing an adjustment to the original budget.  A lower than expected revenue inflow creates a negative variance resulting in a downward adjustment of expenditures. On the flip side, a positive variance results in an upward adjustment of expenditures. These current fiscal-year adjustments are called rebudgeting, and they directly impact the provision of programs and services.  

A common reason for rebudgeting is unintended misestimation of revenue flow. The level of misestimation can vary by revenue source, and are sometimes due to unanticipated economic conditions.  However, some adjustments are intentional, managerial decisions. Decision makers sometimes elect to underestimate anticipated revenue in a proactive attempt to avoid an imbalance or reserve additional funds for other uses. Given that rebudgeting is a result of revenue flow, we take a look at the states’ revenue mix, specifically, the diversification and elasticity of a state’s revenue system.

The revenue data for this analysis come from U.S. census state government finance data series, and from the Comprehensive Annual Financial Reports of individual states. The Bureau of Economic Analysis provides the socio-economic data. The unit of observation is the U.S. state governments each year from 2007-2011. After leaving out observations with missing data, the final dataset consist of 232 observations from 47 states over the five-year period.

We establish five quantitative models that capture factors that affect the occurrence and magnitude of negative and positive revenue variance. Model 1 uses probit maximum likelihood estimation to examine the likelihood of achieving positive revenue variance. For Models 2-5, we use fixed-effects time series regressions with robust standard errors. Models 2 and 3 examine negative revenue variances during our study period. Models 4 and 5 examine the positive revenue variances.

We find that the overall elasticity of the revenue portfolio is negatively associated with the probability of achieving a positive revenue variance, and it is statistically significant at the one percent level. For the states that experience negative revenue variance during our study period, revenue diversification and elasticity show a statistically significant and negative correlation with negative variance. This finding did not hold for the states with a positive revenue variance.