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This study examines the sources of uncertainty in predicting government tax revenues in
Israel. In the first stage, we estimate a model based on several real and financial
macroeconomic variables and identify a significant, stable and highly accurate relation
between these variables and tax receipts. Moreover, we find that, given these variables,
current tax revenues do not improve the projection of revenues. In the second stage, we
test the quality of the model's projections on the basis of available information at the time
the budget is prepared; we find that the forecast error based is six times greater than the
error based on ex-post projection. These results imply that the forecast error
predominantly reflects inaccuracy in the prediction of the explanatory variables and not
misidentification of the relations among the variables. In particular, we find that GDP
projections tend to be overly pessimistic—especially when they are prepared at times of
below-average growth. In the third stage, we ask whether limited versions of the model
predict tax revenues better; we find that the removal of the financial variables and the
indicator for new-dwelling sales does improve the projection. However, models that are
even more limited—based only on lagged tax revenues and a GDP growth forecast—
provide less-accurate projections, and the probability that they will lead to significant
errors in the construction of the budget is greater than that of the broader models.
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