Tuesday, February 25, 2014

Oil and Gas Reserve Fund

*Disclosure: I work for a natural gas company.*

The Senate recently passed a bill for what it calls a Future Fund to set aside tax revenue from oil and gas companies. Here are the particulars: the state will maintain $175 million in oil and gas taxes that it can spend. Twenty-five percent of all the oil and gas revenue after that will be placed in a reserve fund. This fund will earn interest for six years before it can be spent by the government. The main issue is whether this is a prudent, fiscally responsible policy to ensure future financial health, or if using the tax revenue immediately would produce more value during tough economic times.
There is a strong case for the implementation of the Future Fund. It rests on an idea known as the resource curse that has plagued West Virginia in the past, but has had economic impacts worldwide. The basic idea is that countries (and states) with large stores of natural resources often end up with lower incomes, employment, and standards of living than surrounding countries. One glaring example is Venezuela, where $100 billion per year in oil revenue has yet to provide a better life for most of its citizens. Likewise, the phenomenon is present in Africa and the Middle East where autocratic governments hoard the wealth from oil revenue for themselves and at the expense of their populace. West Virginia experienced a form of this with the coal boom in the mid-20th century. This rush temporarily produced employment and tax revenue, but after the easily removed coal had been extracted and technology reduced the need for human labor, many coal towns were deserted. To be fair, the coal industry has continued to provide tax revenues to the state to this day. However, had the funds from this resource extraction been saved and invested in a reserve fund, a smoother transition to jobs in different industries may have been available to past generations.
Norway provides a good example of effectively using a resource reserve fund. That country found large oil reserves off its coast in the 1970s. Instead of allowing companies to extract the oil as quickly as possible, the government handed out a few licenses every year. Then, Norway decided to not spend the new oil revenue immediately on social programs and infrastructure. Instead their government put the money into a pension fund. The Norwegians restricted their government from spending anything other than the interest earned on that pension fund. Today the fund contains about $550 billion. Norway's social programs are envied by countries across the globe due, at least in part, to its oil revenues.
The argument against saving funds from oil and gas revenue rests mainly on urgency. Citizens concerned about high unemployment, high Medicaid costs, and failing infrastructure would rather see new tax revenue spent immediately. While this argument carries some weight, the historical evidence from state and national governments does not support it. There are few examples of governments rapidly exploiting resources then benefiting from years of economic growth due to tax revenues. Instead, future generations could benefit from annual state budgets backed up by a reserve fund. The level and timing of what should be saved or spent can be debated, but the existence of the reserve fund itself has solid economic evidence in its favor. 

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