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What is the impact of the “compromise tax proposal” on the budget and working families?

Earlier this week, the West Virginia Center on Budget and Policy examined the fiscal impact of the proposed compromise tax plan between Governor Justice and Senate leadership that will influence how the budget is finalized. It appears House leadership is saying “nope” to this plan and it is unclear how the plan would close the state’s looming budget gap of $500 million for FY 2018, since a corresponding budget plan hasn’t been put forth. As we noted in our recent report on the budget, the state budget that passed – and was later vetoed by the Governor  – included about $90 million from the Rainy Day Fund and no new revenue increases, along with significant cuts to the Governor’s proposed budget, including Medicaid, higher education, and other programs.

As Phil Kabler notes in the Gazette-Mail, it is also unclear what is currently included in the so-called compromise tax plan being advanced by Governor Justice. It has been rumored the tax plan is the same as Senator Fern’s amendment to SB 484 with the exception that the plan includes the Governor’s tiered severance tax rate changes and not the ones in the Fern’s amendment that significantly reduce severance tax collections.  If this is true, the revenue impact to the budget would be significantly reduced. (For more detailed account of the Ferns Amendment aka the proposed compromise tax plan, see our previous post here)

According to estimates provided by State Tax Department (via email), the proposed severance tax changes in  the Fern’s Amendment would result in a loss of an estimated -$135 million in severance tax collections in FY 2018 and between -$140-$150 million thereafter. Overall, the net result of the Ferns Amendment on the General Revenue Fund, according to the State Tax Department,  is an increase of +$50 million in revenues in FY 2018, and a net reduction of an estimated -$170 million in FY 2019 and FY 2020, and a reduction of -$220 million by FY 2021.

For FY 2018, this includes +$280 million in sales tax increases (7 percent rate and broader base), +$49 million in additional revenue from the new and temporary CAT or commercial activities tax (0.045 percent) and high-income tax surcharge, an increase of +$12 million from ending sales tax transfer to Road Fund from sales tax collected on highway construction, and approximately -$156 million less in personal income tax collections. (Note: The reduction in the personal income tax is -$380 million upon full impact. The income tax reductions do not begin until January 1, 2018, while the other tax changes take effect July 1, 2017 – the beginning of FY 2018 – but start June 1, 2017). It is also important to keep in mind the CAT and high-income tax surcharge expire on July 1, 2020 or the beginning of FY 2021).

If the severance tax changes in the Ferns Amendment are swapped for the Governor’s proposed severance tax rates that are estimated to be close to revenue neutral, this means that the net revenue impact on the General Revenue Fund would be an increase of +$185 million ($50m + $135m) in FY 2018, then a decrease of -$30 million in FY 2019 and FY 2020, and then a reduction of  -$70 million by FY 2021 assuming there is no phase-down of income tax rates.

While incorporating the Governor’s severance tax proposals into the tax compromise plan provides a significant revenue boost during the FY 2018 budget year, the sharp reductions in the income tax when it is fully implemented leads to revenue losses beginning in FY 2019 that will grow the state’s budget deficit and lead to additional cuts to vital programs and services. These declines will grow more over time, with the phase down of the income tax and the expiration of the CAT and high-income surcharge by July 1, 2020.

When all of the tax changes are fully implemented in their first year (not including sales tax transfer from Road Fund), it adds up to $280 million in additional sales tax increases, $49 million in increased revenues from the CAT and high-income surcharge, and $380 million in cuts to the personal income tax. This means the proposed compromise tax plan is actually reducing taxes on West Virginians upon full implementation, not increasing them when it comes to the General Revenue Fund budget.

While the compromise tax plans leads to one year of positive revenue growth for the General Revenue Fund and growing deficits thereafter,  the proposed revenue changes to the State Road Fund would increase revenues by about +$130 million in FY 2018 and +$138 million thereafter (if you do not include the transfer of sales tax collections from the Road Fund to the General Revenue Fund).

Altogether, the revenue changes in the proposed tax compromise plan – including General Revenue and State Road Funds – increase state revenues by approximately $315 million in FY 2018 and $108 million in FY 2019. To be clear, these estimates are subject to change at any time since there is no agreed upon tax bill or a full disclosure of what is being proposed between the Governor and legislative leadership.

The overall impact of these tax and revenue changes on households in West Virginia is the same as as has been reported in previous post, which did not include any severance tax changes because the tax is mostly exported out of the state and unable to be modeled because of difficulties obtaining proper information for the process.

Upon full implementation – which does not include any phase down of the income tax rates or the expiration of the CAT or high-income surcharge –  the proposed tax and revenue changes would, on average, increase taxes on 80 percent of West Virginia households making below $84,000 per year, while lowering them on the 20 percent of West Virginians that make more than $84,000 per year. Those making on average $11,000 per year would see their annual taxes rise by $121 or 1.1 percent of their income, while those making on average $778,000 (top 1 percent) per year would see an average tax cut of $3,713.

This means that the compromise tax plan – if this is in fact it – raises taxes on most West Virginians to help pay for tax reductions for higher-income West Virginians while leaving some revenue to spare in the first year.

The table below breaks out the tax changes for each income group in West Virginia. It includes the full-implementation of income tax reductions in 2018 and the high-income surcharge. While every income group sees an increase in their taxes from the proposed changes to the sales tax, motor fuel tax/DMV fees, and the new commercial activities tax, the large personal income tax reductions mostly goes to the top income groups. In fact, approximately 59 percent of the more than $364 million in income tax cuts go to the top 20 percent, according to the Institute on Taxation and Economic Policy. This is why higher income West Virginians are estimated to receive an overall reduction in taxes while low and middle-income West Virginians see an increase in taxes.

A closer look at the proposed changes to the income tax illuminate this point further. The proposed tax compromise plan condenses the state’s five income tax brackets into three brackets and reduces the rates. For example, instead of a top marginal tax rate of 6.5 percent on income over $60,000, the tax compromise proposal replaces this rate with a top rate of 5.45 percent on income over $35,000. This change will benefit those who have more income.

As the chart below highlights, the personal income tax in West Virginia is based on the ability to pay. This is largely because personal income tax rates increase as income increases. Sales taxes on the other hand, are regressive, taking a larger share of income from low- and middle-income West Virginians. And because those at the bottom and middle spend more of their income on necessities than the wealthy, shifting from the income tax to a greater reliance on sales taxes is a shift in “who pays” from those with more income to those with less income.  Phasing out West Virginia’s income tax would also make the state’s upside down state and local tax system even more regressive over time.

As discussed in a recent report, shifting from the income tax to the sales tax is a poor strategy for economic growth. Academic research and real-world evidence from other states show that there is little evidence that such a shift will significantly boost economic growth, attract more people, or grow small businesses. However, there is compelling evidence that the income tax is a more reliable source of income than the sales tax over the long-term and that the states with more regressive tax structures increase income inequality.

As the Governor and legislature work out a compromise on the budget, including tax changes, they should keep in mind that setting West Virginia on a path of further cuts and just one year of revenue gain is not going to help build a stronger West Virginia where communities can thrive. While it is great to invest additional resources in our state’s crumbing roads and bridges, those gains could be washed away be shortchanging our state’s other needs – including our public colleges, schools, public safety, and health-care services.

Just any tax plan is not a good tax plan. It must be grounded in realistic assumptions and be sustainable over time.  A sound plan cannot rely on false claims about trickle-down economic growth or a sudden surge in coal mining or natural gas extraction. It must provide a reliable source of revenue that can pay our state’s debts and sustain public investments.

As developments of the tax and budget compromise unfold, we will continue to analyze and review them as they are released to the public.

 

Yes, We Should Tax Coal Property Like Natural Gas Property

On Monday, the Joint Select Committee on Taxation met again to discuss revising our state’s tax system. The focus of this meeting was on local property taxation, especially as it impacts the coal and natural gas industries. During the meeting, John Mairs, a lawyer for the coal industry, stated that he “would love to have their taxes assessed like the oil and gas industry.” Presumably, Mairs believes that the coal industry would pay less in property taxes if its property were assessed the same way as natural gas and oil property. However, this is not the case. The natural gas industry has a much higher effective property tax rate than the coal industry.

As Sean and I highlighted in this report, the effective property tax rate on the value of natural gas in West Virginia is about 3 percent compared to just about 1 percent for coal. This is largely because producing natural gas property in West Virginia is valued differently than active coal property. Unlike coal, active oil and gas property is appraised and assessed on both the royalty land-owner and the producer (or leaseholder). Currently, active coal property  being mined is taxed based only upon the royalty rate value of the property, which is typically 5.5 percent of the value, and not the “chattel real interest” or the leaseholders (coal producers) working interest value. This means that a large portion – 94.5 percent, after reducing for operating expenses  – of the value of active coal property is not being assessed and taxed. The result is that coal companies pay much less in property taxes than natural gas and oil companies even though they are paying more on their machinery and equipment.

In 2008, natural gas paid $58.3 million in property taxes based on a production value of about $2 billion – an effective rate of 2.97 percent. Meanwhile, coal paid $90.8 million based on a production value of $9.7 billion or just 0.94 percent. If coal paid the same effective property tax rate as natural gas, it would have paid approximately $288 million or $197 million more in local property taxes. So, yes, taxing coal property the same as natural gas property would be great, as it would be provide additional resources to maintain our highways, and could pay for other important programs that have seen their funding cut over the past several years.

7 Things You Need to Know About Why Coal is Declining in West Virginia (4 of 7)

In the last post, we looked at how West Virginia – especially southern West Virginia –  is being out-competed by other coal regions because of the decline in coal mining productivity that makes it cheaper to produce coal in places like Illinois and Wyoming. Not only do West Virginia coal producers face stiff competition from other coal basins, they see growing competition from large deposits of shale natural gas out west and in West Virginia and, to a lesser extent, from renewable energy.

#4 West Virginia coal is losing steam to natural gas and renewable energy

Over the last several years the amount of coal used for electricity production at power plants in the United States has dropped considerably, from just about 2 billion megawatt hours in 2008 to about 1.6 billion megawatt hours in 2013. This trend is largely driven by the nation’s recent development of shale natural gas. Electricity generated from natural gas grew from about 639 million megawatts in 2011 to over 1.1 billion megawatts in 2013 – growing from 17 percent to 27 percent of the country’s net electricity generation. Coal, on the other hand, has declined over this period from 51 percent to just 39 percent of total electricity generation. Renewable energy has also grown over this period, from about 8 percent in 2001 to over 14 percent in 2013.

fueltype

The shift away from coal and toward natural gas electricity generation is also evident by looking at surrounding states that have relied heavily on West Virginia steam coal for electric power generation. Between 2001 and 2012, West Virginia’s largest domestic customers for steam coal (outside of West Virginia) were North Carolina, Ohio, and Pennsylvania. However, over the last several years West Virginia exported far less coal to North Carolina and Ohio. Meanwhile, Pennsylvania has shifted toward relying more on natural gas for electricity generation.

For example, in 2008, West Virginia shipped approximately 17.7 million tons of coal to North Carolina for electricity production compared to 11.6 million in 2012. Ohio received approximately 13.6 million tons of West Virginia coal in 2008 compared to just 5.1 million tons in 2012. While Pennsylvania imported more steam coal from West Virginia between this period (9.5 million tons in 2008 compared to 11.2 million in 2012), coal used for electricity generation in the state has declined.

From 2008 to 2013, Ohio, Pennsylvania, and North Carolina saw substantial drops in the share of coal used for electricity generation. In Ohio, the share of electricity generation from coal has declined from 85.5 percent to 67 percent since 2008, while in Pennsylvania it has declined from 53 to 40 percent, and in North Carolina it has dropped from 61 to 44 percent over this six-year period. Renewable energy has also grown in these states, from about 3 percent to 6 percent in North Carolina, 2.3 percent to 3.4 percent in Pennsylvania, and 0.4 percent to 1.4 percent in Ohio.

major coal fuel type

As shale development expands with new pipelines and with new natural gas utilities added in the region, the share of electricity from natural gas will likely grow over time in these states, putting more downward pressure on the ability of West Virginia to export coal to other states. As we shall see in the next post, natural gas is also becoming more competitive as the federal government implements rules around the problems associated with global climate change.

7 Things You Need to Know About Why Coal is Declining in West Virginia (2 of 7)

In the last post, I showed that the decline in coal production was heavily concentrated in the southern part of the state. While there are many factors at play, none is probably more important than this one.

#2 lower productivity is at heart of coal decline in W.Va.

If you want to understand why West Virginia and Central Appalachia coal production is struggling, the first place to look is productivity or the amount of coal being produced per hour of work. Productivity is the sine qua non of coal mining. It plays a large role in determining the price of coal, the costs of mining coal, and the profits being made from coal. It also helps explain why some mines are shutting down at the same time others want to open that are less than 100 miles apart.

As the table below highlights, West Virginia – especially southern West Virginia – ranks in the bottom of coal mine productivity. Wyoming can produce 13 times as much coal per hour of work than West Virginia, while Illinois is twice as productive. While Wyoming and Illinois coal has less heat content or BTUs than coal from West Virginia, it still comes out way ahead with Wyoming producing 244,000 BTUs per miner hour compared to just 26,000 in southern West Virginia.   

coal prod hist
Between 2000 and 2012, coal mining productivity has declined by over 50 percent in West Virginia, from about 5 tons per hour to 2.4 tons. As the table makes clear, this is largely being driven by the decline in productivity in southern West Virginia. Meanwhile, productivity in Wyoming – the country’s largest coal producer – has only declined by 27.6 percent and productivity in Illinois – the country’s 5th largest coal producer – has improved by 10.2 percent.  

In most industries, productivity rises each year as technology improves.But with coal mining, the gains since the mid-1980s have not been uniform. Since 1985, productivity has barely budged in Central Appalachia, with eastern Kentucky seeing a decline of almost 7 percent and southern West Virginia with an increase of only 13 percent. Meanwhile, productivity has grown by 122 percent in Illinois, 93 percent in Wyoming and about 50 percent in western Kentucky and northern West Virginia.

The drop in coal mining productivity, despite technological improvements, in West Virginia and the Appalachian region reflects the depletion of the area’s coal reserves. As coal seams get thinner, they becomes more expensive to mine. As Downstream Strategies highlighted in its excellent 2012 report, the central reason for the sharp declines in productivity  in Central Appalachia has been the “the exhaustion of the thickest, most accessible coal seams.” Other factors impacting productivity include demand for coal, mining costs, workforce demographics, mine permitting, and regulatory oversight.

The drop in productivity from the depletion of the area’s coal reserves can also help partly explain the growth in the value of the state’s reduced severance tax rate for thin-seam coal production.

thin seam

According to experts, there also do not seem to be any technological improvements that will increase productivity in the future. The latest projections from the U.S. Energy Information Association also confirm this finding showing that productivity will continue to decline in West Virginia.

coal prod proj

As I will show in the next post, the rapid decline in coal mining productivity in West Virginia has resulted in the state losing coal market share and could make it even harder to compete with other energy sources and coal basins as regulations move forward.

7 Things You Need to Know About Why Coal is Declining in West Virginia (1 of 7)

West Virginia’s coal economy is not what it used to be. In 2013, coal production hit a 30-year low and employment in the industry fell to a nine-year low. While the coal industry and other like-minded people have put most, if not all, of the blame on President Obama and the Environmental Protection Agency’s “war on coal”, the evidence paints a much more complicated picture of a coal region that is in the wake of a structural decline due to market forces and regulations.

Meanwhile, other commentators have written that there is “no war on coal” and that the recent development of shale natural gas is the driving force behind coal’s woes. The problem with this argument is that the growing competitiveness of natural gas for electric power generation is being partly driven by concern over current and future regulations of greenhouse gases. In other words, it is a much safer move for utilities – given the uncertainty of future carbon pollution regulations – to make the switch to natural gas given the growing concerns about climate change.

This series of posts is aimed at providing a more complete picture of why coal is declining in West Virginia. In doing so, policymakers and others will have a better understanding of the root causes of the problem and will be better positioned to guide policy action to meet these challenges.

#1 Coal is declining in southern not northern West Virginia (so far)

 The first thing you need to know about the decline of coal in West Virginia is that it is primarily happening in southern West Virginia. As this chart shows, the recent decline in production is mostly from the southern part of the state, where production has dropped from 130 million tons in 1997 to just over 70 million tons in 2013. Meanwhile, production in the northern part of the state has remained relatively flat since the mid-1990s. In 2013, the counties in the northern part of the state produced over one-third (37%) of the coal in the state, compared to just 21 percent in 2002.

so wv coal production

Perhaps nothing highlights this transition more than the fact that that Marshall County, which is located in the state’s northern panhandle, is now the state’s largest coal producer (2012 and 2013), pushing past Boone County, which as led the state for over three decades in coal production. Between 2008 and 2013, coal production in Boone County dropped by more than half, from 30.3 million tons to just 14.2 million tons. Meanwhile, Marshall County coal production rose over this period from 10.8 million tons to 15 million tons.  

Coal mining employment in West Virginia has also shifted north. In fact, as of the 2nd quarter of 2014, the number of coal miners in the northern part of the state was at a 15-year high of 7,162 according to data from the Mine Health & Safety Administration. Meanwhile, the number of coal miners working in southern West Virginia declined from a high of over 18,500 in late 2011 to just 13,300 by early 2014, a drop of nearly 5,000 jobs. The northern region now makes up about 35 percent of coal mining jobs, its highest share since 2000.

coal jobs north

The decline of coal production  in the south and the relatively stable production in the northern part of the state has to do with many factors (see more in future posts). The northern part of the state, similar to other western coal basins, contains mostly medium and high sulfur coal, while the southern coalfields have mostly low and medium sulfur coal. For years, many coal power plants were able to use low-sulfur coal to meet pollution requirements contained in the 1991 Clean Air Act instead of installing expensive anti-pollution scrubbers at their plants. Eventually through, all of the plants were required to install this equipment and this meant that the low-sulfur coal in the southern part of the state became less competitive as other power plants became outfitted to burn medium and high sulfur coal.

The transition or shift in coal mining from the south to the north is part of a larger structural decline that is taking place in the entire Central Appalachian region. This area, which includes southern West Virginia, eastern Kentucky, western Virginia, and eastern Tennessee, has been declining for well over a decade. From its peak in 1997 of 291 million tons, it has fallen by over half (56%) to just 127 million tons in 2013.  While Central Appalachian coal production began its decent in the late 1990s, it has dropped much faster over the last several years.

 central app coal

From 2008 to 2013, it fell by nearly 46 percent, or from 226 million tons to just 127. As the graph above shows, northern Appalachia produced nearly as many tons of coal as the Central Appalachian Region did in 2013. Corresponding with this decline is the falling share of coal production in Central Appalachia compared to other regions. In 1990, Central Appalachia made up nearly 29 percent of coal production in the United States. In 2013, this dropped by more than half to about 13 percent in 2013. Meanwhile, Northern Appalachian production has remained relatively steady declining from 16 percent to 12.5 percent. Today, both regions account for nearly the same share of U.S. coal production.

 In the next few posts, I’ll explain the factors driving the decline of coal in southern West Virginia and what the prospects look like for the future.

Why is West Virginia GDP Up and Employment Down? Fracking?

Workforce West Virginia recently released 2013 data on employment and wages that show West Virginia has about 7,000 fewer jobs (on average) in 2013 than it did in 2012. In contrast, two weeks ago the U.S. Bureau of Economic Analysis released state data for real Gross Domestic Product growth that showed West Virginia’s economy grew by 5.1 percent from 2012 to 2013 (after adjusting for inflation), which was higher than all but two states. 

How can West Virginia’s economy be growing when jobs are declining? Let’s take a closer look to find out why.

First, let’s look at West Virginia real GDP growth compared to job growth provided by the Quarterly Census of Wages and Employment (which included workers that are covered by unemployment insurance) that is released by Workforce West Virginia. As you can see in these two charts, the relationship between the growth of the economy (real GDP) and jobs has been tenuous over the last several years. While real GDP grew by 16.2 percent since 2002, job growth was an anemic three percent.

real gdp vs job 1

real gdp job 2

The gap in growth in 2012-2013 was especially large, with real GDP growing 5.1 percent while job growth was down one percent. To help explain this disparity, it important to first look at why real GDP grew in the first place. As this next chart shows, it is overwhelmingly due to the the mining sector, which is primarily the coal and natural gas industries. Without this growth of $3.3 billion (40 percent), West Virginia would have experienced negative real GDP growth from 2012 to 2013. 

mining real gdp

The mining sector is also becoming a much larger piece of the state’s economy, accounting for nearly 17.8 percent of the state’s GDP compared to just 6.5 percent in 2002. The recent uptick in the mining sector is due to the boom in shale gas extraction in the north-central part of the state. Meanwhile, West Virginia coal production has declined over the last several years and so has its share of the economy.

Interestingly, the huge jump in mining GDP was not the product of higher wages or employment. Total mining wages declined slightly from $2.6 billion in 2012 to $2.5 billion in 2013 and total mining employment fell by 1,830 (natural gas gained 567 jobs, but looking more broadly at other natural gas sectors like pipeline construction and transportation, distribution, and field machinery, it fell about 173 jobs).

There could be several reasons for the dramatic one-year change in mining real GDP. It could be that the mining real GDP data are wrong, which is always subject to revisions over time, or that the new and more comprehensive revisions of state GDP captured something new in 2013. Or it could be that there was a glut in natural gas storage in the state and that it was finally sold in 2013 at a higher price that boosted productivity and GDP. Another thing to keep in mind is that the natural gas industry is very capital intensive, meaning that it relies less on workers and more on machinery and equipment to produce its value-added product.

While we cannot say with certainty why mining GDP is growing rapidly at the same time wages and employment are stagnating, we can say that it has not translated into broader economic growth in the state in 2013. We can also say that the link between GDP growth and wage growth is not as strong as it used to be. As the chart below shows, wages used to make up over 50 percent of West Virginia’s GDP. Today, they are only 40 percent. There has also been a similar decline in total compensation, which includes pensions, health care, social insurance, and profit-sharing. This means that workers are not benefiting from productivity growth and that more money is flowing to the top via profits and capital income.

Over the last several years, West Virginia has exacerbated this problem by cutting corporate taxes and gutting its estate tax while investing less in higher education and other budget priorities. Reversing this trend in inequality and boosting quality job growth will require policy action at both the federal and state level.

gdp wages and comp

What Did the House Do to the Future Fund?

Yesterday, the House Judiciary and Finance Committees both amended and passed out  Senate Bill 461 and Senate Joint Resolution 14 that creates the West Virginia Future Fund. The amendments made several modifications to how much revenue will flow into the fund over time, how the principal of the fund is protected, and how the state will use the interest income. For an overview of the Senate version of the bill and resolution see here.

The most significant change the House made to the bill was how severance tax revenue would be deposited into the Future Fund. While the Senate version of the bill allocated 25 percent of all oil and natural gas severance taxes collected over $175 million to be deposited into the fund, the House version instead dedicates three percent of annual severance taxes collected on coal, oil, natural gas, limestone, and sandstone that would otherwise be deposited into the General Revenue Fund. Currently, about 86 percent of total severance tax revenues are deposited into to the General Revenue Fund while nine percent are distributed to local governments and five percent goes into the Infrastructure fund (and a very small fraction goes to administration). 

The House version also included several conditions that have to be met in order for deposits to be made into the Future Fund in any given year, including:

1.  The balance of the Revenue Shortfall Reserve Fund has to be least 13 percent of the General Revenue Fund budget.

2. The Governor’s General Revenue Fund estimate cannot rely on using money from the Rainy Day Fund.

3. No mid-year budget cuts, hiring freezes, or allocations from Rainy Day Fund to fill budget gaps.

So how will these changes impact the balance of the Future Fund?

While it is uncertain if these conditions will be met over the next several fiscal years, there definitely will not be a deposit into the Future Fund in FY 2015 under the House version of the bill. This is because the governor has already recommended using $84 million from the Rainy Day Fund in FY 2015 budget.

The stipulation that the Revenue Shortfall Reserve Fund has to have a balance of at least 13 percent of the General Revenue fund could be problematic several reasons. First, because the language in the House amendment does not refer to both Revenue Shortfall Reserve Funds (A & B), it could be very difficult to meet this target. Today, the Revenue Shortfall Reserve Fund (Part A) has a balance of $558.9 million, 13.09% of the Governor’s proposed FY 2015 General Revenue Budget of $4,271 billion. Meanwhile, Revenue Shortfall Reserve Fund – Part B has a balance of $363.5 million. Altogether, the total a balance in the Rainy Day Funds is $922 million or 22 percent of the General Revenue Fund.

If the legislature uses $84 million of the Revenue Shortfall Reserve Fund (Part A) for the FY 2015 budget, the Revenue Shortfall Reserve Fund will only be 11.1 percent of the state’s general revenue fund budget. This means it will have to be replenished over the next few years to exceed 13 percent by raising taxes, cutting the budget or finding money from somewhere else (e.g. an unforeseen economic boom!). Of course, the legislature could increase taxes this year so they do not have to use the Rainy Day Funds but that is highly unlikely in the election year.

It is also important to mention that the the governor’s budget forecast shows a budget gap of $126 million in FY 2016 and $44 million in FY 2017. So this would mean more spending cuts or tax increases if the Revenue Shortfall Reserve Fund is not used. If these budget gap where overcome with tax increases or other revenue, the balance of the Revenue Shortfall Reserve Fund would have to grow dramatically to stay above 13 percent of the general revenue fund budget.

For example, the governor’s budget projects that the general revenue fund budget will be $4,727 billion in FY 2016 and $4,977 billion in FY 2017. This means the Revenue Shortfall Reserve Fund will have to grow to at least $615 in FY 2016 and $647 in FY 2017. If we assume that least $84 million will be used in the FY 2015 budget, this means the Revenue Shortfall Reserve Fund will need to grow by $140 million by FY 2016 and $172 million by FY 2017. Extremely unlikely unless we have giant surpluses over the next few years.

If we conclude that all of the above conditions will be met over the next several years – a big leap of faith, I might add – the future balance of the Future Fund will likely be much lower that it would have been without these changes. Based on severance tax projections from the West Virginia Department of Revenue, the fund will have a balance of about $72 million in FY 2019 compared to $127 million in the Senate version of the Future Fund. This is because the benchmark included in the House version – three percent of total severance tax revenues – is much lower than the benchmark in the Senate version of 25% of natural gas and oil severance tax collection of about $175 million. And because the House version benchmark begins with severance tax revenue deposited into the General Revenue Fund – and not the total amount of severance tax revenue included in the Senate version – it also depresses the amount of revenue flowing into the Future Fund.    

Hosue Version of Future Fund

Other House Changes

The House’s amendment also clarified that “tax relief” was an appropriate use of the money that could be spent from the Future Fund so it matched the language in the Senate Joint Resolution 14. The House Judiciary Committee also stipulated that “infrastructure” would include “post-mining land use.” All fine.

The only other significant change made by the House was to the constitutional amendment proposed on SJR 14. Instead of making the fund permanent – meaning that the only way to spend the principal of the fund was by a vote of the people – the House included an amendment that the legislature could spend the principal of the fund if two-thirds of each house of the legislature agrees. The problem with this amendment is that it hurts the integrity of the Future Fund by giving the legislature, instead of the people, the option to spend all of the money in the fund. This language also conflicts with the language in the bill that says the principal of the Future Fund “shall remain inviolate” and not be appropriated.

Conclusion

If the House amendments are not changed, it could significantly lower than amount of funds that are eventually deposited in the Future Fund and it could curb public support for making the fund constitutional. The one bright spot in the House amendments to the Future Fund is that it includes other nonrenewable resources like coal.

To strengthen the Future Fund, the Legislature should consider several options. First, it should clarify that deposits to the Future Fund are predicted on the balance of both Revenue Reserve Shortfall Funds. Secondly, it should consider increasing the amount of revenue that would be deposited into the Future Fund. This could include increasing the percent of severance tax collections dedicated to the fund or increasing the share on just natural gas and oil collections. And finally, the Future Fund should remain permanent, rather than allowing the legislature to spend the principal of the fund.

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

Coal Production Shifting to Northern West Virginia

Nothing highlights the shift in Appalachian coal production more than Boone and Marshall County, West Virginia. For as long as I can remember, Boone County was always #1 in coal production. Today,  Marshall County, which is located in the north-west part of the state, is the state’s biggest coal producer at 17.2 million tons (compared to 15.8 million in Boone County.)

As we’ve highlighted several times over the years, this development should not come as a shock. In fact, projections from the U.S. Energy Information Administration (EIA) have consistently shown central Appalachian coal production falling steeply while northern Appalachian coal production slightly increasing over the coming years.  And this is exactly what has happened.

One reason for this shift is that southern West Virginia steam coal is running out and it is becoming too expensive to produce. As the chart below shows, coal mining productivity has declined dramatically over the last decade in West Virginia. While this is good news for coal miners in the short-run because it means more jobs (ironic that coal mining jobs were higher in 2011 and 2012 than they were at any any time over the last 18 years and yet the “war on coal” campaign is stronger than ever), it eventuality means higher coal prices and stiffer competition that will reduce employment in the medium and long run. As the chart below shows, there is an inverse relationship between coal mining employment and productivity. As productivity declines, employment goes up. 

Coal Employment & Productivity

 A closer look below reveals that coal production in the northern part of West Virginia has slightly increased (49.3 to 49.9 million tons) from 2008 to 2012. Since 2000 it has grown by about seven million tons (42.8 million).* Southern coal production, however, has dropped from 116 million tons in 2008 to just 79 million in 2012. In 2000, the southern counties produced almost as much as the entire state in 2012 at 126.6 million tons. The northern counties also are making up a much larger chunk of the state’s coal production, growing from 25 percent in 2000 to 39 percent in 2012. Meanwhile, the southern part of the state has seen a decline from 75 percent in 2000 to 61 percent in 2012.

norhtsouthcoal production

While both coal-producing regions have seen sharp drops in productivity between 2008 and 2012, the decline in productivity in southern West Virginia has been nearly twice as acute.  In 2008, the annual tons produced per miner in the southern coalfields were 7,489 compared to just above 5,000 in 2012 – a drop of 32 percent. In the northern part of the state, the decline from 9,169 to 7,731 was only about half or 15.7 percent.  The sharper drop in productivity  – and the overall lower rates of productivity  – in the southern coalfields highlights how uncompetitive the market is for central Appalachian coal compared to coal produced in the northern part of the state. 

northsouthproductivity

While both regions experienced job gains during this four-year period – partly because of a decline in productivity – most of the job gains where in the northern part of the state. From 2008 to 2012, the number of direct coal miners increased from 5,337 to 6,460 in northern West Virginia – a gain of 1,083 – compared to an increase of just 86 jobs (15,550 to 15,626) in the southern coalfields.  The number of coal-mining jobs in the southern part of the state is most likely much lower today. According to state data, there were nearly 2,400 fewer coal miners in West Virginia in December 2013 than in 2012.

With the drop in coal production and employment in southern West Virginia, political leaders and other stakeholders should engage in a constructive conversation about the future the region. Just recently, more than 1,700 people gathered in Pikeville, Kentucky to do just that.

Instead of waiting like Kentucky until we lose 6,500 coal mining jobs, our state leaders need to take action NOW.  Because without a plan for the future, and without a broad recognition that coal mining is not going to rebound in southern West Virginia anytime soon, we are likely to see our state’s economic problems go from bad to worse.

 ____

 *Southern Coal Counties: Boone, Clay, Fayette, Greenbrier, Kanawha, Lincoln, Logan McDowell, Mercer, Mingo, Nicholas, Raleigh, Wayne, and Wyoming.

 *Northern Coal Counties: Barbour, Braxton, Brooke, Grant, Harrison, Marion, Marshall, Mason, Mineral, Mononghalia, Ohio, Preston, Randolph, Taylor, Tucker, Upshur, and Webster.

Moving Toward an Energy Transition

The Charleston Gazette had another timely editorial on Monday (I’ve been out of town all week) urging West Virginians to embrace the state’s changing energy economy by creating solutions for the ongoing transition.

As the chart below highlights, coal production has declined markedly over the last decade while natural gas is at unprecedented levels. As we’ve discussed before, these trends will continue in the coming decades as the economic (and political) power of the state shifts to the northern part of the state  – where gas production will continue to boom and coal will still be an important player, unlike the southern part of the state where coal is declining rapidly and shale development is materializing more slowly. 

coalgas2000to2012 

In a recent article in the Martinsburg Journal, West Virginia Commerce Secretary Keith Burdette stated:

“We want to take the products and create added value products,” he said. “We do not want West Virginia to be an energy colony. We want to make the products here. We want to take advantage of this opportunity this time, which we’ve missed other times.”

Burdette is absolutely right. If the history of West Virginia has taught us anything, it is that natural resource extraction does not exactly go hand-in-hand with a shared prosperity. That’s why it is so important that we have adequate taxation of our mineral resources, a plan for when they run out, and a idea for how to ensure a just transition as coal declines.