By Robert Roach
It’s blasphemy, but when Peter Lougheed decided in 1976 to put 30 per cent of natural resource revenue into the Alberta Heritage Fund, he got it wrong. It should’ve been 100 per cent.
In Lougheed’s defence, he got it a lot less wrong than the premiers who came after him, and he didn’t have the benefit of hindsight. The last 40 years on the resource revenue roller-coaster show that the best way to deal with the volatile and intergenerational nature of resource revenue is to transform it into a permanent financial asset that produces a steady stream of annual revenue.
When oil prices are high, we have huge surpluses that are difficult to spend wisely on the fly. When prices are low, we have a budget hole that has to be rapidly filled by a haphazard combination of debt, cuts or higher taxes. This encourages overspending in good years and underspending in bad. It also undermines accountability, as windfall cash is used to plug rather than properly repair holes in the ship of state.
Putting the revenue in the bank and only spending the interest (after inflation-proofing the principal) does not eliminate volatility, as the fund’s earnings will fluctuate over time. Nonetheless, while occasional market corrections can be severe, a well-managed fund’s earnings will be much less volatile than resource revenue.
A fund also allows Albertans to get more bang for their resource buck by growing that buck through sound investments. The money is not put in a mattress. It’s put to work so it can grow in value and generate returns that can be used to fund programs or reduce taxes in perpetuity. Spending the money as it comes in simply depletes the asset.
If you decide to save less than 100 per cent, you get some of the benefits of saving, but you don’t maximize them. What’s worse, is that you remain addicted to the volatile revenue that you don’t divert into the fund.
The save-it-all-and-spend-the-interest approach allows for much better planning and accountability. It also reduces the shocks to the economy and the unrealistic spending expectations created by large windfall infusions of government cash.
In addition, diverting resource revenue into a fund is the only way to guarantee that future Albertans benefit appropriately from the sell off of the province’s natural resource endowment.
It’s a simple principle: current spending should be paid for by current residents. But what about infrastructure that is used by future residents and investing in education today so we have the skilled workers we need tomorrow? Since future residents benefit from these things, they should help pay for them through the use of today’s resource revenue and “smart” debt.
This would make sense if these were exceptional one-time expenses akin to a family taking out a mortgage to buy a home, but infrastructure and education are routine annual government expenditures. Using the future’s portion of our resource endowment to pay for them just means that future residents won’t have that portion when it’s their turn to fund annual infrastructure and education costs.
And don’t forget that today’s residents have the fund’s earnings to help pay for current expenditures, so it’s not like saving means no one in the present benefits.
The existing Heritage Fund demonstrates the power of saving. Slightly less than $18 billion in deposits and retained earnings have generated $35.5 billion of investment income and it will keep generating billions in perpetuity. This shows what can happen when you convert resource revenue into an income-generating financial asset. Even the limited saving that has taken place has paid off in a big way.
The kicker is that it will take a number of years to build the existing Heritage Fund to a size where its earnings are equal to or greater than the resource revenue we have been spending on an annual basis. This is where theory and politics collide and the result is not pretty.
A government that decides to make the switch, even if it phased it in over several years, would have to vastly improve the efficiency of the public sector (a worthy goal on its own), cut programs or temporarily raise taxes to the tune of several billion dollars a year.
Albertans need to decide if they want to feel the pain now so they can reap benefits later, or stay on the resource revenue roller-coaster and let future Albertans pay the bill.
Robert Roach is a senior fellow at the Atlantic Institute for Market Studies. He is author of the recently released policy paper A Good Problem to Have: Lessons for Atlantic Canada from Alberta’s Experience with Natural Resource Revenue. The opinions in this piece are the personal views of the author.