The Role of State Revenue Structure in the Occurrence and Magnitude of Negative Revenue Variance

Abstract

A negative revenue variance (also known as a revenue shortfall) is generated when the actual inflow of revenue falls short of the budgeted revenue. In an environment constrained by a balanced budget requirement, a negative revenue variance may result in a compensating cut in program expenditures. As such, it is imperative to explore the drivers of negative revenue variance. To answer these questions, we take a look at the states’ revenue mix, specifically, the diversification and elasticity of a state’s revenue structure. We establish a quantitative model to capture factors that affect the occurrence and magnitude of negative revenue variance. Our findings suggest that revenue diversification reduces both the occurrence and the size of a negative revenue variance. Elasticity, on the contrary, increases the occurrence but reduces the magnitude of the negative revenue variance. These findings provide additional evidence for the importance of fiscal planning and design of revenue structure that includes consideration of both diversification and elasticity of the revenue portfolio. Specifically, elasticity and diversification can be used in tandem to address an existing revenue shortfall.