As New Mexico legislators grappled with budget deficits, they raided cash reserves from various accounts just to pay the bills, some of which were past due.
But New Mexico also is one of a few states with a sovereign endowment from energy and mineral deposits that locks away money for future generations.
A report by the Pew Charitable Trusts on state finances is the first systematic study of state severance tax funds, money earned when natural resources such as oil, natural gas, potash, uranium and copper are removed or severed from the land.
The report, “From Volatile Severance Taxes to Sustained Revenue,” says just five states have meaningful balances in these endowments, and New Mexico’s $4.7 billion is the third highest in the country after Alaska and Wyoming. A measure to create a reserve for energy royalties goes before Louisiana voters next month. West Virginia created a fund for its vast coal deposits in 2014.
Pew’s interest in looking at severance tax wealth funds is part of a long-term project on fiscal health in the states to bring best practices to investments and raise awareness about how diminishing resources can be conserved for future generations.
“Failure to invest resource wealth represents an enormous missed opportunity,” writes Brenna Erford, manager of the state fiscal health and economic growth project at the Pew Charitable Trusts. “A lesson that many states have learned from the current drop in energy prices.”
Severance tax funds in the United States hold a combined value of $70 billion, according to the Pew report. The 77 sovereign wealth funds outside the United States in countries such as Russia, Kuwait, China and France have $8.2 trillion in assets.
The report points to some best practices from the funds in New Zealand and Canada, which have a longer history of extraction industries than those in the U.S.
In New Mexico, the Severance Tax Permanent Fund was created by the Legislature in 1973 and given constitutional protection by voters three years later. Money from it is used to pay off capital construction projects around the state known as severance tax bond projects. Money is also transferred every year to the state general fund, which pays for the day-to-day operations of state government, from courts to public education.
The fund distributes 4.7 percent of its five-year average to the general fund. That reached $193 million in 2016 and will be more than $200 million in 2017.
But money coming into the fund has not been that stable.
In the 1990s, the state was depositing half of all its severance tax proceeds into the investment account — and that propelled its growth from $1.3 billion in 1989 to $4.1 billion in 2000. The balance today stands at $4.7 billion.
In 1999, as part of a constitutional challenge to the fairness of school funding in the state, New Mexico was ordered to pay more money to low-income school districts, and a portion of that funding came from severance taxes. As of 2015, 95 cents of each dollar from the tax was being diverted to pay for schools and other government services.
That meant almost all of the asset growth came from investment gains. “With very little coming into the fund, you have to invest your way to prosperity and that isn’t always possible,” said Charles Wollmann, spokesman for the State Investment Council, which manages the fund as well as the larger land grant endowment.
In 2015, the Legislature and Gov. Susana Martinez moved to reset the deposits. In a measure signed into law, deposits will grow from 5 percent of the taxes to 14 percent by 2019, a boost of $390 million over 10 years, according to estimates. The higher asset base will in turn boost payouts by about $10 million a year.
Pew’s Erford said disciplined deposits and strict policies on withdrawals are keys to growing these funds.
Alaska’s severance tax fund was established just as the Trans-Alaska Pipeline was set to open in 1976. Aided by steady deposits and a strict withdrawal policy, it has grown to $52 billion. The new fund in West Virginia prohibits the state from using the principal or earnings until after 2020.
Erford said Pew is also aware that other states can benefit from establishing funds, including Oklahoma, Texas and even Ohio and Pennsylvania.
“A severance tax-based sovereign wealth fund is one tool policymakers could consider to answer the challenges posed from a high reliance on these taxes, as it can help transform this volatile, finite tax stream into more permanent, revenue-generating assets,” the report states.” This type of long-term savings fund provides opportunities for states that collect this type of revenue to generate long-run investment earnings while managing the volatility of the revenue flowing to the general fund.”
Among Pew’s recommendations:
u Identify the purpose of a sovereign wealth fund and clearly articulate its goals in law.
u Establish policies for the governance, investment and public disclosure with clear guidance and transparency.
u In order for funds to build a large interest-generating balance, the principal must remain intact. While withdrawals can help address short-term needs, they diminish the fund’s long-term goal of generating investment revenue.
u Policies governing investment and withdrawals should take into account the volatility of resources such as oil and natural gas.
Even with its billions, New Mexico’s severance tax fund pales compared with the land grant endowment, which earmarks lease and other revenue from state trust lands to public schools and government operations. That account had a balance of $14.8 billion at the end of August.