Forecast Bias and Capital Reserves Accumulation

Abstract

Governments create implicit fiscal slack with biased revenue and expenditure forecasts. In turn, they can use implicit fiscal slack to build explicit fiscal slack in reserve funds. Evidence of the relationship between implicit and explicit fiscal slack is growing but focused on the general fund. This study examines that relationship in the unique context of capital funds. With a panel dataset of Kentucky school districts from 2001 to 2013, this study estimates two-way fixed effects panel models and shows mixed evidence of the implicit-explicit fiscal slack relationship across the type of capital fund. Specifically, there are small but statistically significant effects of revenue and expenditure forecast bias on building fund fiscal reserves, but not for other capital funds in Kentucky. The mixed findings can be attributed to the unique institutional context and fund definitions in Kentucky, which helped to foster budgetary flexibility across reserve accounts. Future studies should investigate the implicit-explicit fiscal slack relationship in school districts and general-purpose local governments like cities and counties. To do so, researchers can utilize the framework developed in this study to help build a growing literature on the relationship between government forecasts and slack resources.