What it means
Minerals can be dug or pumped out of the ground only once, so a state that depends on them has a problem. If it spends every dollar of mineral revenue as it arrives, the money disappears when the resource runs out.
Wyoming's answer was to set aside a share of the revenue permanently, invest it, and spend only what the investments earn. The fund was approved by voters in 1974 and receives a share of the severance taxes (taxes charged on removing minerals from the ground) along with certain other mineral payments.
Its principal is protected by the state constitution, which means ordinary legislation cannot simply spend it. Changing that rule would require another constitutional vote, which makes the savings hard to raid in a bad budget year.
The earnings are what the state can use. They are transferred to the general fund, which pays for services such as schools, roads and public safety, and they reduce the pressure to raise other taxes.
Because the principal stays invested, the fund can keep producing income for future generations long after the mineral industry shrinks. For an outside reader the fund is a useful case study in public finance.
It shows how a government can smooth the ups and downs of commodity prices, reduce its dependence on a single industry and build an asset that outlives the activity that created it. Several other resource-rich places run similar funds under different names.
The nuance is that a fund of this type does not remove risk. Its earnings depend on investment markets, so they rise and fall from year to year, and a state that comes to rely on them can still face a budget gap when markets fall.
The size of the annual contribution also depends on mineral prices and production.
In practice
Real-world examples.
Example
A state legislator argues for protecting the principal of a mineral trust fund, pointing out that spending it would give a one-time boost to the budget but leave future taxpayers without the income. The fund therefore keeps paying every year.
Example
A finance student at a university compares the Wyoming fund with the sovereign wealth funds of oil-producing countries. She notes that both save part of a non-renewable windfall, though the Wyoming fund is much smaller.
Example
A municipal bond analyst reviews a state's credit. The existence of a large permanent fund, with a protected principal and steady earnings, is counted as a financial strength that supports the state's credit rating.
Formula
Calculation
Annual spendable earnings = fund principal x net rate of return
Suppose a fund like this holds $8,000,000,000 and earns a net return of 4% in a year. The earnings are 8,000,000,000 x 0.04 = $320,000,000, which can be transferred to the general budget. The principal stays at $8,000,000,000. If a bad year produces a return of 1%, the earnings fall to 8,000,000,000 x 0.01 = $80,000,000, which shows why budgets built on fund earnings need a cushion. These figures are illustrative and not the fund's actual results.Case study
Seen in the real world.
Pinecrest State is an illustrative, fictional state that earned $600,000,000 a year from coal severance taxes. For years the legislature spent every dollar, and the budget grew accordingly.
When coal demand fell, the revenue dropped to $200,000,000 and the state had to cut services and raise other taxes. A new finance chair proposed a permanent fund modelled on the Wyoming example, with a constitutional rule that 30% of mineral revenue, about $60,000,000 a year, would be saved and invested.
After twenty years the illustrative fund had grown to well over $1,000,000,000 and was producing earnings that covered a meaningful part of the school budget. The lesson is that saving part of a temporary windfall in good years makes the bad years much easier to survive.
Watch out
Common mistakes.
- Thinking the principal of the fund is spent each year, when the principal is protected and only earnings are used.
- Assuming the fund's income is stable, when investment returns rise and fall with markets.
- Confusing the fund with a pension fund, when it is a savings fund held for the state as a whole.
Questions
People also ask.
When was the fund created?
It was established in 1974 after Wyoming voters approved a constitutional amendment.
Who benefits from the earnings?
The earnings flow into the state's general fund, so they support public services and reduce the need for other taxes.
Can the legislature spend the principal?
Not under ordinary law, because the principal is protected by the constitution and a change would need a further constitutional amendment.
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