As Hawaii’s top executive, the governor signs bills into law and appoints judges.

But when it comes to financial matters, even the governor answers to a higher power.

Four times a year, the Council on Revenues, a little-known advisory board of mostly economists and academics, makes predictions about Hawaii’s economy that spell out how much money the government can spend.

The council’s statements have instantaneous impacts.

If the council predicts tax revenues are going up, the state can spend money. If the council anticipates a shortfall, the state reins in spending and looks at ways to raise revenues, such as tax hikes, and ways to save money, such as pay cuts and furloughs.

But a review of the group’s forecasts over the last five years shows that the council’s predictions are rarely on target. In three of the last five years, the council made initial forecasts that overestimated how much the state’s tax revenues would grow by nearly double. The discrepancies are worth noting because each percentage point translates into tens of millions of dollars.

“When you’re looking at revenue growth, one percentage point is about $46 million. So when we go from, say, a minus 3 percent projection to an actual of minus 5 (percent), that’s a big deal,” said Senate President Colleen Hanabusa.

In fiscal year 2008, actual year-over-year growth was 1.2 percent, but the council had predicted increases ranging from 3.9 percent to 6 percent. At most, its forecasts overestimated tax revenues by $240 million.

The next year, during fiscal 2009, tax revenue tumbled 9.5 percent. But the council initially predicted 2 percent growth over the previous year. It later adjusted its forecast downward. That year, the council’s quarterly forecasts for the year overestimated tax revenue by as much as $630 million.

Asked about the council’s accuracy during the economic downturn, Speaker of the House, Rep. Calvin Say, said he was “bothered” by the group’s optimism and said he tried to work with the panel to adjust its predictions to “be on the safe side.”

“I felt that the council was always on the optimistic side, which bothered me,” Say said. “I’m a realist and I like to know exactly how we’re doing in the housing market, in the tourism industry, the building industry. And I thought they were very generous in appropriating more funds knowing there was a downward spiral in the economy.”

The group’s chairman, economist Paul Brewbaker, said: “It’s a constant work in progress how we approach the forecasting. We’re reasonably sure we get the numbers right, but stuff like Lehman Brothers shutting down, Aloha Airlines going out of business, H1N1 virus — we didn’t see those coming.”

The council was created during the 1978 Hawaii State Constitutional Convention. It prepares forecasts on state revenues for each fiscal year as well as quarterly estimates that include all taxes and income owed to the state. The governor prepares her state budget proposal based on the council’s pronouncements. The Legislature incorporates the council’s forecast into its negotiations on the governor’s budget.

Conceived as an independent nonpartisan third party to complement the governor and Legislature during the budget process, the council is supposed to help prevent the Legislature from spending money it doesn’t have.

Four times each fiscal year — June 1, September 10, January 10, and March 15 — the council predicts how much tax revenue can be expected to funnel into the state’s general fund. And twice a year — every August 5 and November 5 — the council predicts total personal income, a factor in computing the state general fund expenditure ceiling.

“It might seem strange, but it’s a better system than the Legislature or the governor having to explain to the public on what basis we think state revenues will be, say, $5 billion versus $4.8 billion,” Hanabusa said.

Only one other state has its budget tied to forecasts by an independent panel, according to the National Conference of State Legislatures.

For the most part, a state’s governor and lawmakers make separate projections and then negotiate a budget, according to the nonprofit group. Only South Carolina has a group similar to the Hawaii Council on Revenues: a four-member Board of Economic Advisors established in the 1970s as the “chief economic advisor and general economic consultant to the state.” The South Carolina advisory group is required by state law to provide revenue impacts to lawmakers for proposed legislation, and also performs revenue forecasting and evaluation of revenues for all state programs.

In Hawaii, by law, the governor and lawmakers are required to consider the council’s predictions in preparing the state budget, appropriating funds, controlling expenditures, and enacting any revenue-related legislation.

In the past, the group was exclusively made up of economists, but the current lineup includes a mix of academic economists and financial executives from the public and private sectors, who hold down full-time jobs while serving on the council.

Current members of the Council on Revenues, selected by the governor, Senate president and House speaker, are:

  • Carl Bonham
  • Paul Brewbaker
  • Dean Hirata
  • Pearl Imada Iboshi
  • Richard Kahle Jr.
  • Jack Suyderhoud
  • Albert Yamada

Brewbaker is the group’s chairman and official spokesman. Brewbaker concedes that the council was caught off-guard by the unexpected impact of the recession.

“When you have a period like the 1980s through 1991, when the Gulf War ended, and from 2001 to 2007, nobody cared what the forecasts were — there was always going to be more revenue each year,” said Brewbaker. “But when you hit a turning point, that’s when it becomes pivotal. No economic forecasting is accurate at turning points.”

Coming Up With the Numbers

Getting seven financial experts to agree on a projection isn’t easy.

He said each member comes to the table with an individual forecast using a variety of complicated models that factor in eight to 10 economic variables that are thought to influence tax revenues.

“At the end of the day, it comes down to interpreting what all of the data tells us and we have to sit in a room and make a decision,” Brewbaker said. “We reach a forecast with what’s available at the moment and based on how we expect conditions to evolve. How we get there is like that old joke about making sausage — do you really want to know?”

A look back at the council’s tax revenue projections over the last five fiscal years, including before the recession hit, highlights that the council’s forecasts are just that — forecasts.

Anticipating Rosy Forecasts

The group consistently underestimates Hawaii’s personal income by about $2 billion a year. The measure Legislators care most about concerns tax revenue growth.

Legislators say they’ve learned to anticipate overly optimistic forecasts from the council.

“Three or four years ago, the sentiment was that the council’s projections were too high,” said Hanabusa.

“It can be problematic when the council’s projections are off. When we’re put in a pinch is whenever they are off in either extreme — too high or too low,” she added. “In past years, when we’re trying to balance the budget based on what the Council on Revenues says, we can be left in a position where we feel we have to pass a budget that needs to include revenue enhancements or savings. For example, this year, we proposed suspending payouts of Act 221 (high technology tax credits), a move estimated to create a $93-million savings.”

“If the Legislature was told that the projections were going to in fact be lower, we could’ve taken different actions earlier on than taking a big hit one time, and forcing the governor to take drastic steps like she did this year — holding up state tax refunds, imposing pay cuts and furloughs.”

At the start of the 2009 fiscal year, the council projected the state would have $1.2 billion less revenue than anticipated through June 30, 2011. A review of Gov. Linda Lingle‘s statements on the budget last fiscal year reveal how influential the council’s forecasts are:

  • In response to the council’s March 2009 forecast, Lingle proposed cuts in wages and benefits to state workers.

  • In December 2009, Lingle announced plans to eliminate an additional 700 state jobs — on top of about 1,200 cuts previously announced in July 2009 — to balance the state’s budget, following the council’s latest revenue forecast. Approximately 800 of the positions were already vacant.

  • Also in December 2009, Lingle announced plans to delay payment of $275 million in anticipated state tax refunds in 2010.

  • Then in May 2010, following a revised forecast from the Council on Revenues (from a negative 2.5 percent growth to a positive 4 percent growth), Lingle gave the Hawaii Tax Department the green light to begin issuing state income tax refunds that were processed during the months of January and February 2010.

Room for Improvement

Brewbaker said “there’s opportunity to improve the forecasting process,” noting that while the council is administratively attached to the state Department of Taxation, it does not have a dedicated support staff to help with research.

In its most recent forecast dated June 2010, the Council on Revenues noted signs of economic recovery, and is projecting year-over-year tax revenue growth of 6.2 percent in fiscal 2011, 5.8 percent in fiscal 2012 and 5.7 percent in fiscal 2013. (The U.S. economy grew 2.4 percent in the second quarter of 2010.)

“The recovery is happening faster than most people are prepared to accept as plausible,” Brewbaker said.

Nationally, the U.S. economy is growing at a “moderate” pace, but has a “considerable way to go to achieve a full recovery,” Federal Reserve chairman Ben Bernanke said Monday. He said the weak housing market and high unemployment rate are stunting growth, but that an increase in spending by households and businesses should help sustain growth in upcoming quarters.

“With economic conditions far from normal, state budgets will probably remain under substantial pressure for a while, leaving governors and legislatures a difficult juggling act as they try to maintain essential services while meeting their budgetary obligations,” Bernanke said.

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