Parkland Institute Research: Reports

published April 14, 2008

Saving for the Future:

Fiscal Responsibility and Budget Discipline in Alberta

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Executive summary

Saving for the Future

What will our economy look like when our non-renewable resources have dwindled? Where will our government obtain revenues for vital social programs? Will we be able to rely on our own savings, or will we need to go cap-in-hand to Ottawa?

After years of Parkland Institute and others calling for more responsible management of our non-renewable resources, the government struck a Financial Investment and Planning Advisory Commission to study the issue of savings. The Commission has reported to government, but the government has yet to release the Commission�s findings or reveal its intentions.

In the current boom the Alberta government has an opportunity to act, but this opportunity will disappear as available resource wealth declines. Now is the time for a responsible approach to saving, investing and benefiting from Alberta�s non-renewable resource wealth.

<h5>Goals</h5>
For many years, the provincial government has single-mindedly focussed on eliminating the financial debt. Now Alberta is in a new reality � a period of surpluses and savings. Yet the government has not adjusted its plans or budgets to reflect this new reality. There is a need for an inclusive social discussion to define appropriate provincial goals that should guide its savings policies.  This section of the report draws from the literature and public debate on Alberta�s fiscal management to help launch that discussion.

<strong>Long-term savings.</strong> Albertans own the resources, and the rents arising from their extraction. Rents are the value of the resource when sold, minus costs of production (e.g. exploration, extraction, transport) and a normal, competitive level of profit for the developer. The rents consist of two parts: royalties retained by the owners (the public) and windfall profits (a.k.a. unearned income) taken by the developers. Alberta�s government has a duty to manage rents not just for today�s voters, but also for our children and future generations. Non-renewable resources are a form of natural capital � an asset for all Albertans. As they dwindle, we will need to ensure we can still pay for essential public programs.

Unfortunately, Alberta�s government treats royalties as if they were ordinary revenues to be spent, instead of assets to be maintained.

Royalties have been used to artificially suppress taxes. Indeed, without liquidating our royalties, Alberta�s government would have been running deficits for each of the past 20 years, adding up to a total debt of over $85 billion.

If the government had placed all non-renewable resource royalties in the Heritage Savings Trust Fund after the net debt was eliminated eight years ago, the Fund would be worth $135 billion (instead of $16 billion).  It would already yield earnings of at least $7 billion per year, above inflation.

<strong>Fiscal stabilization.</strong> The provincial government�s addiction to volatile non-renewable resource wealth causes major fluctuations in revenues. And its insistence on never running deficits translates that revenue fluctuation into expenditure fluctuation. In order to stabilize revenues and expenditures, non-renewable resource rents should be removed from general revenues, and replaced with more reliable and predictable revenue streams.

<strong>Diversifying the economy.</strong> Alberta�s economy has been dependent on energy for decades, and continues to be so. This creates a vulnerability to fluctuating global commodity prices, as was experienced by Alberta in the 1980s and �90s. Alberta�s non-renewable resource rents should be held and deployed in a manner that helps to diversify its economy.

<strong>Economic stabilization.</strong> Alberta�s economy has a pronounced boom- and-bust cycle, with alternating bouts of unemployment and inflation. The government�s procyclical spending exacerbates that cycle. When the business cycle is low, the government cuts spending, thereby throwing people out of work. When the economy is booming, the government spends more, driving up inflation. Government spending can and should do the opposite. Alberta�s non-renewable resource rents present an opportunity to spend in a way that mitigates the boom-bust cycle.

<strong>Responsible fiscal management.</strong> Alberta�s government has a history of lowballing budgeted revenues, and declaring �surprise� surpluses that are a surprise to nobody. The government should more honestly manage its non-renewable resource revenues and budgeting, using accurate, even-handed forecasts and making decisions transparently.

The other part of behaving responsibly is behaving ethically. Alberta�s energy savings could boost renewable energy development, and pursue other ethical investment goals. Ethical investments often have superior financial performance, and enjoy increasing popular support. Alberta�s energy savings should be invested ethically, to obtain social, economic and financial returns for their owners.

<h5>Policies arising from the goals</h5>

Policies on both sides of the ledger � income and spending � can help achieve our goals.

<h5>Income-side policies </h5>
<strong>Saving our surpluses.</strong>  For years Alberta�s government has spent budgeted and �surprise� surpluses on a range of tax cuts, discretionary spending, and giveaways like the $400 �Prosperity Bonus� cheques. Instead of reacting to surpluses by dissipating them, government should place 100% of surpluses � budgeted and �surprise� � into the Heritage Savings Trust Fund.

<strong>Saving our non-renewable resource rents.</strong> Because non-renewable resources will decline, many argue that the rents should be saved. The �Hartwick Rule� of economics holds that in economies dependent on non-renewable resources, ensuring future generations are as well off as we are requires transforming resource stocks into capital that will produce earnings for future generations. Nevertheless, weaning the Alberta government from its addiction to easy money, and replacing it with sustainable revenues, will take time. This report recommends that over a four-year period all non-renewable resource rents be phased out of general revenues and placed in the Heritage Savings Trust Fund.

<strong>Increasing Albertans� share of the non-renewable resource rents.</strong>  Alberta�s government has a duty to maximize the rents it retains for the owners � not to keep a �fair� share, or strike a �balance.�

However, the government has been giving away much of the rents, and continues to do so under its new Royalties Framework.  The idea that industry will pack up and leave if royalties are increased is an empty threat. Clearly it didn�t happen after the new Framework was announced, despite dire warnings. This is because risks here are low, and profits are high � recently breaking records on a yearly basis.

Even if retaining rents did push back some investments into the future, this could results in higher overall revenues as oil prices rise, a more orderly pace of development, and a level playing that allows other sectors to secure more investment. Alberta�s government should increase its retention of non-renewable resource rents so that within four years Albertans are keeping 100% of rents, and energy corporations are making normal, competitive levels of profit.

<strong>Can Alberta backfill the non-renewable resource rents?</strong> Removing non-renewable resource rents from general revenues would leave a gap that needs to be filled. The size of the gap would be less than $8 billion per year, and it turns out that this can readily be filled. 

Merely adopting a tax system competitive with other provinces would generate $8 to $15 billion. An even larger amount could be raised by instituting a carbon tax (or expanding the �non-tax� industrial carbon charge Alberta instituted last year). Whatever strategy the government adopts, replacing the non-renewable resource rents is feasible. Alberta�s government should embark on a democratic, transparent process for determining a strategy for doing so.

<strong>Wise and ethical fund management.</strong> Norway�s Petroleum Fund � over 20 times larger than Alberta�s Heritage Savings Trust Fund � is managed ethically. And it is unlikely that Albertans would support every profitable investment opportunity regardless of the harm it causes here or elsewhere. Heritage Savings Trust Fund moneys should be invested ethically.  And to address �resource envy� a significant portion should be invested in equity holdings outside of the province, including some in renewable energy development.

<h5>Spending-side policies</h5>
Maintaining the trust. Alberta government policy has decimated the Heritage Savings Trust Fund for the past two decades, wiping out half of its per-capital value and two-thirds of its per-GDP value. Inflation protection has recently been restored, but earnings are still skimmed off. The Heritage Savings Trust Fund should be maintained and expanded: capital should never be removed from it, and earnings should go to inflation-proofing before anything else.

<strong>Building a nest egg.</strong>  As Alberta�s non-renewable resource economy shrinks, the government may be unable to raise adequate revenues to support essential programs like health, education, and social assistance � programs that may be in greater need at that time. Alberta�s government should allocate half of Heritage Savings Trust Fund earnings above that needed for inflation-proofing to a new Alberta Permanent Trust. The Permanent Trust would match or supplement government spending in these areas when needed. The government should also commission regular forecasts to determine whether the Permanent Trust will require greater resources.

<strong>Orderly spending: responsive, non-partisan, transparent.</strong> The government has already established a number of funds: the Medical Research Endowment Fund; the Scholarship Fund; the Energy Innovation Fund; etc. Well-managed arms-length spending can potentially increase transparency, reduce cronyism, and limit bad investing. However, the existing funds operate with a melange of discretion and rules, inviting abuse and limiting transparency.  The existing funds should be reconfigured as arms-length foundations, governed by common rules to ensure accountability and transparency, and employed to spend the Heritage Savings Trust Fund earnings not required for inflation-proofing or the Alberta Permanent Fund. 

<strong>New spending priorities � rationalizing the process.</strong> Priorities will shift over time, and the government should regularly review existing foundations against spending needs, as determined by an objective, transparent public process. The government should create new foundations as needs require and resources permit, and shut down those no longer a priority. Having a number of foundations will result in a wide range of grants and recipients, thus contributing to economic diversification.

<strong>Countercyclical spending.</strong> Removing non-renewable resource rents from general revenues will help reduce procyclical spending. However, our economy could be further stabilized by countercyclical spending policies, e.g. requiring most foundation spending to occur during periods of relatively high unemployment. Other policies could help stabilize Alberta�s economy in the longer term, e.g. developing the renewable energy sector in Alberta.

<strong>Sustainability fund and capital account.</strong> Given that the non-renewable resource rents would be removed from general revenues, the fiscal shock-absorber provided by the Sustainability Fund is less important. The Sustainability Fund should be replaced by a normal budget cushion of 3.5% of budget, to be funded by ordinary revenues.

Capital spending also can and should play a stabilizing or countercyclical role.  The Capital Account should be moved into the Heritage Savings Trust Fund and renamed the Alberta Natural Capital Replacement Foundation, with spending rules as per the other foundations. Immediate-term, urgent spending on our current infrastructure debt can be handled with normal financing as in other provinces, i.e. general revenues and ordinary debt.

<h5>Conclusion </h5>
Alberta�s government can manage its citizens� non-renewable resources rents better. Following the above recommendations would raise the Heritage Savings Trust Fund to over $200 billion in just ten years. This sum would yield over $10 billion in earnings above inflation � significantly more than the government�s projected royalties.

Alberta�s resource revenues have already begun to fall off, and having a solid savings and investment framework is increasingly urgent. The recommendations in this report are achievable. They would help to stabilize the government�s finances and make planning, budgeting and program and financial management easier. And they would help diversify the economy, make it more sustainable, and mitigate the boom-bust cycle. Most importantly, these recommendations would help to serve the needs of Albertans � now and in the future.

ISBN: 1-894949-18-8

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Hard copy available for $10.00 plus $2.00 for shipping (GST included).

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