Tax Revenue Forecast Errors: Wrong Predictions of the Tax Base or the Elasticity?

In this paper, we disentangle tax revenue forecast errors into influences stemming from wrong macroeconomic assumptions and false predictions of the elasticities linking the tax base to its corresponding tax type. Across six tax types and the overall tax sum for Germany, we find a heterogeneous degree of relative importance of both sources. Whereas wrong macroeconomic assumptions matter most for profit-related taxes and the wage tax, false predictions of the elasticities mainly drive the forecast errors of the energy tax and the sales taxes. For the overall tax sum, more than two-third of the error can be attributed to wrong macroeconomic predictions and approximately one-third to false assumptions on the elasticity. Our results suggest that outsourcing the macroeconomic projections to an independent forecaster and methodological improvements can reduce tax revenue forecast errors.