Giant Step for Future Fund, but More Work Ahead

Late Saturday night, the Legislature passed SB 461 that created the West Virginia Future Fund. While this is an important step forward, the bill included the adopted house changes that I focused on last week. The most significant changes included a new funding mechanism and several conditions that have to be met in order to deposit money into the Future Fund. Unfortunately, these changes will very likely preclude any deposits made into the Future Fund for several years.

Instead of adopting the Senate version which deposited 25 percent of all natural gas and oil revenue above $175 million, the Future Fund will now receive three percent of general revenue severance tax collections on coal, oil, natural gas, limestone and sandstone. The three percent will not include local severance tax distributions or the $23 million that goes into the infrastructure fund in calculating the share that would be deposited into the Future Fund. In addition, the three percent does not include “natural gas liquids” which are expected to grow from $10 million to at least $35 million over the next few years. 

As discussed earlier, deposits into the Future Fund can only happen if Rainy Day Fund A (Revenue Shortfall Reserve Fund) is above 13 percent of the General Revenue Fund budget. As Senator McCabe said on Saturday night, this condition will not likely be met for many years because of the state’s revenue problems – which are mostly due to self-inflicted tax cuts. To give you an idea of why it will be so hard to meet this trigger, the chart below looks at a couple of scenarios.

RDF Projections

Currently, Rainy Day Fund A is 13.3 percent of the General Revenue Fund Budget for FY 2014. This will most likely drop significantly after the end of the week when the Legislature passes its final budget for FY 2015. The House plans to use at least $84 million from the Rainy Day Fund A for its FY 2015 budget (per the Governor’s request) to pay for Medicaid, while the Senate version of the budget would use $125 million from the Rainy Day Fund. This would put Rainy Day Fund A at 11.1 percent or 10.2 percent, respectively. So this means no deposits in the Future Fund in FY 2015.

What about in later years?  In order for Rainy Day Fund A to be at 13 percent in FY 2016 it will need an additional $140 to $181 million. Usually the only way money grows in the Rainy Day Fund is through deposits made from budget surpluses (80% of surpluses will now go into the RDF A) or interest accrued in the fund. The interest income from the fund would likely be no higher than eight percent, so it will take at least a surplus of $110 million next year (unless there are deep cuts to the budget) for a deposit to be made in the Future Fund. The same goes for the outer years. The only foreseeable way this could change is a boom in shale development beyond beyond what is baked into future budgets or some other type of economic miracle.

How can we fix this problem? Two actions: 1) the state desperately needs to increase its revenue base (e.g. increase tobacco products’ taxes) so it can fill in current and future budget gaps in order to stop depleting the Rainy Day Fund. Without this action, it doesn’t look likely anything will ever flow into the Future Fund; 2) combine both Rainy Day Funds (A & B) or alter the language in the code to include both funds in the trigger. That way, it meets the 13 percent threshold trigger. To strengthen the Future Fund, it also needs to include “natural gas liquids” or it could just say “all severance taxes” collected.

This all being said, the Legislature should be commended for taking a great step toward creating the Future Fund. Now we just need to be sure that it gets the funding it deserves and that it’s constitutionally protected.

The Future Fund Can Build a Better West Virginia

The West Virginia Senate has unanimously passed SB 461 that creates the West Virginia Future Fund and an accompanying resolution (SJR 14) to make the natural gas and oil severance tax fund constitutionally protected (inviolate). As most readers know, the WVCBP has championed the idea for several years and we are excited the state is moving forward in ensuring that it will  always benefit from its rich nonrenewable resources.

What I would like to do below is answer some common questions about the West Virginia Future Fund and explain how it could potentially work and how the balance of the fund will grow over time. At the end, I will also put forth several ideas for future consideration that would make the fund stronger and provide more bang for the buck.

What is the West Virginia Future Fund?

It’s a permanent mineral trust fund that is funded by 25 percent of natural gas and oil severance tax revenue over $175 million. For example, if the state collected $200 million in natural gas and oil severance revenue next year, approximately $6.25 million (25% of $25 million) would be deposited into the fund.

What is the purpose of the fund?

The purpose of the fund is to take revenue from a nonrenewable natural resource that is depleted over time and replace it with a renewable source of permanent wealth for the state. Otherwise, severance tax revenue will decline along with the nonrenewable natural resource itself. The fund would also ensure that future generations benefit from the state’s rich natural resources.

What makes the fund permanent? 

It’s permanent in that the principal or corpus of the fund is inviolate and can never be spent. Only the interest income from the fund can be used.  The only way to make the fund permanent is to constitutionally protect it, otherwise legislators could raid the fund each year.

How will it be used?

The revenues deposited in the fund will be invested and grow larger over time. After fiscal year 2020, it could begin to pay out dividends or interest income to fund to a range of activities, including education, workforce development, economic development and diversification, infrastructure improvements, and tax relief. 

Who will manage the West Virginia Future Fund?

The revenues deposited in the fund will be managed much like a state pension fund or an endowment at a foundation or university. The account will be in the WV Treasurer’s Office and will be invested by the West Virginia Investment Management Board.

How is the Future Fund different from the Rainy Day Fund?

The Rainy Day Fund is usually only used by the governor in a time of emergency (he has to repay the fund within 90 days) or by the legislature whenever there is a a severe decline in revenue or a crisis that needs immediate funds. The Future Fund is better thought of as a sunny day fund that will grow each year and be used each year to make investments in the state. One similarity is that both funds help with the state’s bond rating or credit score by building assets.

How many state’s have future funds?

While many states have land mineral funds where they collect royalties from mineral extraction (e.g. Permanent University Fund in Texas), several states dedicate a portion of their severance tax revenue into a permanent trust fund that is used every year. These states include Alaska, Wyoming, North Dakota, New Mexico, and Montana. For a more detailed look at these states, see this handout.

How big will the Future Fund be in the coming decades?

As Yogi Berra once said, it is tough to make predictions, especially about the future. That being said, we can say with some certainty that we are only in the beginning stages of the shale revolution and that natural gas and oil severance taxes will continue to grow for some time. According to the West Virginia Department of Revenue, natural gas and oil taxes will grow from $83 million in FY 2013 to $270 million by FY 2019. Based on these figures, and a 7.5 percent annual investment rate of return, the Future Fund would have a balance of about $127 million by the end of FY 2019. I would also stress that these figures are most likely very conservative.

Balance of FF

How can we make the West Virginia Future Fund stronger?

To be clear, the first order of business should be to pass SB 461 and SJR 14 and then work over the next few years to make sure the fund builds enough wealth to begin investing in crucial areas that will help our state grow. To strengthen the fund, it would need to include a larger share of gas and oil severance tax revenue and it would need to include revenue from coal production. One option for accomplishing this would be to maintain the Workers’ Compensation Debt tax on coal (56 cents per ton) and natural gas (7.7 cents per MCF) that will expire in 2016. This could add at least $100 million per year to the fund. Another route would be to look at raising the severance tax by one percent, like we proposed in this report, or by levying a tax on midstream natural gas products like ethane.  

A share of the dividends or interest income payments from the fund could also go back to the communities of origin. One fantastic model for this would be creating a regional board similar to the Iron Range Resources and Rehabilitation Board in northeast Minnesota that invests in companies, non-profits, and workforce development in the area to help create economic opportunity.

Lastly, the state could take steps to ensure that the Future Fund is as transparent and accountable as possible. This would need to include building a website that would give citizens details on how the money is be investing and used each year.  One model for this would by the Alaska Permanent Fund Corporation.

Most importantly, however, we must create the West Virginia Future Fund this year and start building a better future.

Fast Facts on Future Fund PDF