The Washington Post’s GovBeat blog highlights a report out of the Pew Charitable Trusts on the declining accuracy of state revenue forecasts:

For the past 27 years, states have gotten worse and worse at forecasting revenue, according to a recent report. But don’t blame the forecasters, the authors say. Errors became larger from 1987 to 2013 because revenue became increasingly volatile.

The Pew report highlights the role of capital gains, which are inherently hard to forecast, in the declining forecast accuracy:

[M]any state officials say they have been surprised in recent years at the increase in volatility of sales and personal income tax collections. For personal income taxes, the most volatile component is capital gains, which are largely contingent on an unpredictable stock market as well as other factors, such as investor behavior, that are difficult to anticipate. For example, stock prices may go up, but individuals may choose not to sell their holdings. Or the market may be flat, but because of prospective changes in tax law, people realize capital gains that have accumulated over a number of years.

Changes to the federal tax code shape investor decisions as to when and whether to take capital gains:

One of the trickiest issues surrounding capital gains is that the timing of tax collections associated with this type of income depends on the economy and taxpayers’ behavior. The spike in collections during the recent federal budget showdown called the fiscal cliff exemplifies how taxpayers’ actions can add to volatility. Throughout 2012, many high-income taxpayers realized that their rates could go up in January 2013, because Congress was signaling it would not renew tax cuts enacted during George W. Bush’s presidency that were scheduled to expire. In response, many taxpayers accelerated capital gains into 2012 to take advantage of the lower rates. Such changes also affected state income tax revenue, and forecasters could not predict by how much taxpayers would shift capital gains realizations from 2013 to 2012. The resulting 2012 surge in capital gains was basic tax planning for payers and led to unusually high collections when taxpayers filed their 2012 tax returns. For 2013, capital gains filings were much lower.

Preliminary estimates from the IRS are that capital gains fell by 12.5 percent from tax year 2012 to tax year 2013. And this was in spite of the fact that the stock market (measured by the Russell 3,000) rose by more in 2013 (28.0%) than in 2012 (18.6%).

The recent period of extraordinary capital gains income has coincided with a period of extraordinarily low federal capital gains tax rates. In 1997, under President Bill Clinton, the maximum federal tax rate on long-term capital gains dropped from 28 percent to 20 percent. In 2003, under President George W. Bush, the rate top rate dropped to 15 percent. These low rates may have contributed to to the volatility by increasing investors’ willingness to take capital gains. On January 1, 2013, the top capital gains tax rate jumped up to 23.8%. It may be that we will see fewer capital gains and more predictable revenues going forward because of this higher rate.

Irv Lefberg, who for many years was an economist with the Office of Financial Management, was one of two external reviewers of the Pew report. He surely deserves some of the credit for the high quality of the report.