Statement 5: Revenue
Appendix D: Forecast methodology and performance
The Government's revenue estimates are prepared using a 'base plus growth' methodology. The last known outcome (2007‑08 for the 2009‑10 Budget) is used as the base, to which estimated growth rates are applied resulting in revenue estimates for the current and future years. The growth rates are determined from forecasts for a large range of economic data, many of which are described in Statement 2.
The smaller and relatively simple heads of revenue, such as luxury car tax and many of the excises, are forecast by mapping an appropriate economic parameter growth rate forecast directly to the tax growth rate. Most of the large and complex heads of revenue, such as personal and company income taxes, are forecast by mapping appropriate economic parameter growth rates to the various income, expense and deduction items on the relevant tax returns. An estimate of total tax payable is then calculated by applying the statutory rates to the estimated income base. Timing models based on past payment behaviour assist in determining whether this tax will be paid in the year the income is earned, such as for pay‑as‑you‑go withholding tax, or in future years, such as for individuals' refunds.
Other information affecting revenue forecasts includes known tax collections for the current year, new policy, and properties of the calendar (for example, more pay‑as‑you‑go withholding tax is paid on a Thursday than any other day so years with 53 Thursdays will result in more revenue than years with 52 Thursdays).
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 2007‑08 Budget forecast taxation revenue to grow by 4.8 per cent in 2007‑08, compared to the outcome of 9.3 per cent, a forecast error of 4.5 percentage points. It should be noted that, in contrast to this trend, the estimate for revenue in 2008‑09 is expected to be significantly lower than the 2008‑09 Budget forecast.
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 D1: Budget forecast error on taxation revenue growth
(excluding GST)
Source: Treasury estimates.
Chart D2 shows the relationship between forecast errors of the economy and 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 (CGT) 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 models 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 ¾ 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 be theoretically 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.
Source: Treasury estimates.
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.
Tax revenue in 2007‑08 was bolstered by around $18 billion of CGT, an increase of more than 50 per cent from the previous year and an increase of more than 200 per cent since 2004‑05. This unusually large growth was driven by unforeseen strength in both the stock market and house prices, resulting in a forecast error on tax revenue outside of the expected range given the forecast error on nominal non‑farm GDP growth. Abstracting from CGT, the estimated forecast error on tax revenue in 2007‑08 was around 3 per cent of total revenue, which is within the expected range given the error on nominal non‑farm GDP.
After allowing for economic forecast error, 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, 2006‑07 and 2007‑08 illustrate the benefits of the improved forecasting methodology.
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