There are a few reasons we recommend that mineral receipts be saved only in a Permanent Fund as the new non-wasting asset. First, by insisting on all amounts being saved in the Permanent Fund, we are insulating the budget from the boom & bust commodity cycle. When prices are high, revenues expands, and politicians expand expenditure to match. When the prices crash, so do revenues but expenditure is much harder to cut back. If we insist that all amounts are saved, this vicious cycle is broken. It also reduces the incentives for politicians to recommend conversion of minerals to cash at inappropriate times – many governments, such as Venezuela, are in a budget crisis due to the oil price crash, but are forced to sell more oil at the worst possible time.
Second, most possible investments such as in infrastructure, health and education are not “non-wasting” assets. Bridges have a finite life. While it could be argued that the first person in a family to get education is an investment, as they would educate the following generations. However, once the population is educated, further education is an investment that dies along with the individual. Governments are notoriously inefficient in their investments. This problem is worse in developing nations. Consider how poor the returns are from our investments in government run schooling. Much capital is likely to be wasted, cheating our chidren. Professional investment management will achieve better results.
The key reason for saving all the mineral receipts is to ensure that politicians do not have access to easy money from minerals – easy money corrodes governance as the social contract of paying taxes for good governance is broken. 100% is an absolute standard. If even 1% went to the budget, it would be tempting for politicians to argue for a higher share of the receipts into the budget. As Alaska shows (discussed later), a split of mineral receipts between the government and the Permanent Fund is very hard to defend.
Lastly, if the Permanent Fund is invested overseas, it would mitigate overall risk. Aspects of Dutch Disease such as overheating the economy and strengthening the exchange rate would be mitigated, thereby keeping the rest of the economy competitive.
The present budget crisis in Alaska presents an instructive lesson. Only 25% of the receipts from oil have been saved in the Alaska Permanent Fund, while the balance 75% has been treated as revenues in the government budget. As a consequence, Alaska does not have a state income tax. With the recent crash in oil prices following soon after the China boom, the Alaska budget is in shreds. The politicians continue their efforts to raid the Permanent Fund, via the dividend – easy money, avoiding the politically more difficult task of instituting an income tax and providing good governance in return. In turn, legal battles have begun around the Permanent Fund Dividend.
Worse still, the Alaska governor is now proposing that the Permanent Fund invest in the Government directly, in “tax credits” with no repayment date! This will almost certainly ensure the demise of the Permanent Fund. Had the more difficult decision been taken to invest all the oil receipts into the Permanent Fund, and invest the Permanent Fund exclusively outside Alaska & oil in order to diversify risk, these issues could have been avoided. The budget would not have increased with oil prices, and consequently, would not have to adjust. The Permanent Fund Dividend would be four times larger instead, over US$8,000 a year.
The same issues have arisen in Wisconsin around their coal severance taxes and the Permanent Wyoming Mineral Trust Fund. The same dynamic appears. Only 2.5% of taxes from coal were deposited into the fund. The budget is in a crisis, and the government is looking to the fund to bridge its deficit.