Appendix D: Forecast Performance
The Government's revenue forecasts, like all forecasts, are subject to a margin of error. Since 2000‑01, revenue forecasts have tended to under‑predict the revenue outcomes — Chart D1. For example, the 2006‑07 Budget forecast taxation revenue to grow in 2006‑07 by 4.4 per cent, compared to the outcome of 7.0 per cent, a forecast error of 2.6 percentage points.
Chart D1: Budget forecast error on taxation revenue growth
(excluding GST)
The revenue forecasting error may be split into three underlying sources: errors in the forecasts of the economy underpinning the forecasts; errors in translating the economy to revenue forecasts; and miscellaneous factors such as post‑budget government policy decisions, court decisions regarding tax law interpretation, changes in ATO compliance activities and their success, and revisions to historical economic data. Note that there may also be secondary errors relating to the timing of the payments of tax: even if the forecasts were accurate, revenue may be recorded in the fiscal year before or after it was expected.
Chart D2 shows the relationship between forecast errors of the economy and for tax revenue over recent years. The dotted lines in Chart D2 represent a theoretical range for the relationship between the economic and revenue forecasting errors.
- Nominal non‑farm GDP has been chosen as a broad indicator of the economic forecasts. Not all tax revenues are closely linked to GDP — capital gains tax for example — and some of the sources of error described above are independent of economic conditions. So the relationship in the chart will only be approximate. The lines assume a revenue forecasting error of plus or minus 0.5 per cent if there is zero error on the economic forecasts.
- On average, economic forecasting errors will be magnified in the forecasting errors for revenue growth due to the progressive nature of personal income tax. The lower and upper lines assume aggregate elasticities (of revenue with respect to nominal non‑farm GDP) of 1.0 and 1.5 respectively, which are consistent with theoretical modes of the tax system after broadly allowing for uncertainties such as capital gains tax and the timing of payments.
Broadly, points below this range represent forecasts of tax revenue growth that were too high given the economic growth forecasts and points above the range represent too low forecasts of revenue growth given the economic growth forecasts.
- For example, in 2002‑03 nominal GDP growth turned out to be around of a percentage point higher than forecast but growth in tax revenue was almost 4 percentage points higher than forecast — higher than the around 1 percentage point error that the rule of thumb suggests should theoretically be associated with an economic forecasting error of that magnitude.
Chart D2: Budget forecast errors on nominal non‑farm GDP growth
and taxation revenue growth (excluding GST)
The lower line combines a base error of ‑0.5 per cent with an elasticity of 1.0, and the upper line combines a base error of +0.5 per cent with an elasticity of 1.5.
Part of the forecast errors in 2001‑02 and 2002‑03 should be partially offsetting, due to uncertainties regarding the timing of company tax during the reduction in the company tax rate from 36 per cent to 30 per cent in two stages between 1999‑2000 and 2001‑02.
Over the last seven years, revenue has been most seriously under‑estimated in 2000‑01, 2002‑03 and 2004‑05, pointing to problems with revenue forecasting methodology in those years. In recent years, forecasting methodology has been improved: see Box 5.2 in the 2007‑08 Budget, Box 5.2 in the 2006‑07 Budget and Box 5.1 in the 2005‑06 Budget. While the number of observations is small, the revenue forecast outcomes in 2005‑06 and 2006‑07 illustrate the benefits of the improved forecasting methodology.
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