What Do States Identify as Challenges in Forecasting Long-Term Expenditures?

The views expressed are those of the author and do not necessarily reflect the views of ASPA as an organization.

By Deborah A. Carroll, Christelle Khalaf & Thao Pham
August 2, 2024

In the aftermath of a $1 billion underestimate of Medicaid expenditures in Indiana’s April 2023 forecast, Governor Eric Holcomb issued a statement explaining that the state had “begun a deep dive to understand the factors driving the spending increases and what is causing the unanticipated growth.” The forecasting error prompted Cris Johnston, the director of the Indiana Office of Management and Budget, to note in a news article that “challenging assumptions that are going into this forecast with what is really happening on the ground” need to be incorporated into the state’s practices.

This example of a recent forecasting misstep highlights the need for research focused on the challenges states face as they produce their long-term expenditure forecasts. The current literature and guidelines mainly focus on revenue forecasts, leaving expenditure forecasts, especially long-term ones, unaddressed. In an effort to explore and gain a deeper understanding of these issues, the Government Finance Research Center (GFRC) at the University of Illinois Chicago recently released a report focused on these issues, as commissioned by The Pew Charitable Trusts.

Nationally, 30 states publish long-term expenditure forecasts, while the remaining may have forecasts of some kind, but they are not published. For example, some forecast comprehensively for internal purposes only, others forecast some of their budget components (mainly Medicaid and education), and the remaining do not produce forecasts at all. Among those that do have published expenditure forecasts, there is a great amount of variation in the challenges they present to states

The GFRC’s research began with an effort to identify the variables associated with expenditure forecasting challenges. Based on a review of academic papers, technical reports and other relevant materials, characteristics associated with expenditure forecasting challenges were identified, and the states were grouped into eight clusters, each associated with a different primary challenge. Then, interviews were conducted with subject matter experts from offices of budget, finance, planning or management in states representing each of the eight groupings to inform the research findings.

Some states describe the use of simplistic forecasting approaches as a challenge. For the most part, the expenditure forecasting process is anchored in historical trends. In fact, most offices receive forecasting of some budget components from other specialized governmental departments. Therefore, policy changes, economic conditions and/or structural changes to the economy are not typically incorporated into forecasts until they materialize. Other procedural challenges relate to flexibility in forecasting methodologies used, validity of assumptions, and statutory restrictions. For the most part, however, states did not express challenges associated with the current methods or data used.

Generally, larger expenditure categories and caseload-driven forecasts were found to be most challenging. One of the main underpinnings of long-term expenditure forecasting is demographic changes. However, most states did not communicate that pension or debt service expenditures posed significant challenges to their forecasting process.

Consistently across states, the most challenging aspect of long-term expenditure forecasting is the uncertainty introduced by Medicaid. This challenge is a function of the magnitude and nature (e.g., real-time payments, complex cost structure) of expenditures. For example, in 2021, state governments spent roughly $796 billion or 26.8 percent of total expenditures on social insurance programs, rendering this category the largest spending component in state budgets. This spending forecast is further complicated by the shared fiduciary responsibility with the Federal government, as well as the unpredictability of healthcare costs and the financial status of providers.

In terms of spending frequency, for some states, the challenge revolves around differentiating between one-time versus ongoing spending, which is often a discretionary decision and may require evaluative judgement. Most states that publish their forecasts begin with their current services baseline, an approach following recommended best practices.

Communication also emerged as an issue of concern. For some, communicating the nature of forecasting to stakeholders is complicated as it can involve explaining the role of unknown factors in creating a forecast as well as varying levels of knowledge across stakeholders regarding statutory requirements.

All of these issues are exacerbated in some states by the absence of efforts to preserve and expand institutional knowledge as well as the strain of efforts to remain current with new advances in forecasting techniques.

Going forward, a partnership focused on producing best practices and common standards that can leverage the existing prevalent culture of collaboration across states could alleviate some of the challenges that states face. Critically, statutory hurdles would need to be considered before more sophisticated modeling techniques or other changes to forecasting processes, in line with best practices, could be adopted.

Moreover, an initiative that provides targeted training to stakeholders, with an emphasis on reaching legislators and the press, could address many of the communication challenges described in this research. This initiative might have the added benefit of indirectly facilitating the adoption of best practices as it can help increase interest and visibility of long-term expenditure forecasts.

Finally, a centralized database of resources could provide key support to states as they tackle unexpected expenditure forecasting challenges. This database can preserve past knowledge and provide a platform to keep states up-to-date with curated information regarding new skills, insights, techniques and other relevant information.

---

Authors: Deborah A. Carroll is the director of the Government Finance Research Center (GFRC) at the University of Illinois Chicago. Christelle Khalaf is the associate director of the GFRC. Thao Pham recently completed her PhD in public administration at UIC and will soon join the Government Finance Officers Association. The GFRC shapes and informs public policy and scholarly discourse on government and public finance by identifying, planning, and executing research, providing reports and informed analyses, delivering educational opportunities and technical training, and offering inclusive venues to convene national and local discussion on fiscal and governance issues. This article was written under the auspices of Katherine Barrett and Richard Greene of Barrett and Greene, Inc.

 

(No Ratings Yet)
Loading...