BC's Prosperity Fund: A Good Idea if Designed Properly

BC’s governing Liberals presented a Throne Speech recently that included an unexpected announcement: the creation of a BC Prosperity Fund similar in concept to Alberta’s Heritage Fund. BC’s fund is meant to capitalize on the future opportunities from natural gas development. If done correctly, the Prosperity Fund could be a huge benefit to both current and future British Columbians. As with many things though, the devil is in the details.

Thankfully there are lessons to be learned, and avoided, from our neighbours. Specifically, Alberta provides stark lessons on what not to do when establishing such a fund while our other neighbour, Alaska, provides an equally plain positive lesson.

The first and most important lesson is that the rules of the fund will to a large degree determine its success.

With respect to contribution requirements, Alberta has none. Contributions are completely at the discretion of the current government. And unfortunately for Albertans, the government has unwisely used this discretion. For example, the government has made no resource-related deposits into the fund since 1987.

In contrast, Alaska has a constitutional requirement to deposit at least 25 per cent of specified non-renewable resource revenues into the fund. The state government increased that requirement, albeit legislatively, to 50 per cent of revenues from new oil and gas fields.

A key lesson for British Columbia in establishing the Prosperity Fund is to remove or at least limit the discretion of the provincial legislature with respect to contributing to the fund from designated resource revenues. More specifically, the legislation for the Fund should specify the contribution rates for royalty income as well as leases, and any other revenues directly linked to non-renewable resource extraction.

A second difference between Alberta and Alaska that is arguably more important than the contribution rate is how the earnings of the Fund can be used.

Alberta’s Fund provides the province with almost complete discretion on how earnings of the Fund can be used, which explains why since its inception almost all of the earnings have been removed from the Fund and transferred to the government to finance spending. Since 1977 when the fund was created, it has earned net income of $31.3 billion but the government has withdrawn $29.6 billion (95 per cent of the earnings) to support spending. It’s worth noting that over the same time period, less than one per cent of Alaska’s Permanent Fund earnings (cumulative) have been transferred to the government to finance spending.

This is the key reason why the value of the Alberta Heritage Fund is comparatively low. In 1988 when the government ceased making contributions from resource revenues, the Fund’s value stood at $12.6 billion. As of 2011, some 23 years later, the Fund’s value was $14.2 billion. In other words, the nominal value of the fund hasn’t changed over almost a quarter of a century.

Alaska, on the other hand, specifically requires a sufficient amount of the earnings of the fund to be retained to protect against inflation. Since its inception, also in 1977, Alaska’s Permanent Fund has retained 31 per cent of its earnings to protect against inflation. This in part explains the much higher value of Alaska’s Fund ($40.1 billion as of 2011) compared to Alberta.

Another key difference is how the Fund benefits citizens. In Alberta, citizens benefit indirectly because the Fund provides revenues to the province to support spending. (It’s debatable that the spending itself has actually benefited Albertans). In Alaska, however, citizens benefit directly via dividend payments from the Fund.

Each year eligible Alaskans receive a direct payment from the Permanent Fund based on the five-year average earnings of the Fund. These payments cannot reduce the principal or the earnings retained to protect against inflation. Since the fund began, the Alaska Permanent Fund has distributed dividends totally $19.2 billion or 46 per cent of the Fund’s total earnings. In 2011, for instance, it meant an average payment of roughly $1,000 (U.S.) per eligible citizen.

If BC’s Prosperity Fund were to consider such payments, it should only be implemented after the Fund has eliminated the province’s substantial debt.

The key to the success of the Prosperity Fund, however, is inextricably linked with its rules. Alaska and Alberta provide stark performance differences over time based almost exclusively on widely differing rules. Getting the rules right for BC’s Prosperity Fund could establish the foundation for enormous benefits for both current and future British Columbians.