Response to Comments on Betting on the Future with a Cloudy Crystal Ball: Revenue Forecasting, Financial Theory, and Budgets
Public Administration Review (online version), Vol. 67, No. 5, pp. 88-93, September/October 2007
6 Pages Posted: 22 Apr 2008
Budget policymakers should focus on expected revenue growth (average growth over history) and on the risk or volatility around that average. It makes sense to think about this risk as having two components purely random risk unrelated to the economy and risk associated with an economy that is hard to predict. Budget policymakers should reduce random (unsystematic) risk by building a diversified revenue portfolio within the constraints of practical tax policy objectives. They should use hedging, reserve funds, and other strategies to offset risk that cannot be diversified away the risk associated with the underlying economy and unsystematic risk that is not practical to diversify away. And, they should adopt spending rules that will balance the budget over the long run while allowing it to be unbalanced in any given year. They can do this by balancing the present value of revenues against the present value of spending over the long run or, second best, by balancing over the business cycle.
Keywords: fiscal sustainability, revenue forecasting, volatility, mean-variance analysis, tax-portfolios, covariance, martingales
JEL Classification: C53, D73, D80, D23, E60, E34, G11, H61, H63, H70
Suggested Citation: Suggested Citation