by Andy Wu, Mukund Sundar, Frank Xiong, Hao Jing, Mingyu He (University of British Columbia)

Savings Funds and Rainy Day Funds are proposed by governments as method to save funds which are to be used for various purposes. In a similar vein to the Alberta Heritage Trust Fund (AHTF), the Alaska Permanent Fund (APF), the British Columbia Liberal Party has established a savings fund called the Prosperity Fund. Since the Prosperity Fund is fairly recent, not much academic research or discussion regarding its structure or value has occurred.

We will discuss why the Prosperity Fund does not make fiscal sense. We will look at the rules that are set up to govern the Prosperity Fund and show why these rules will not ensure the long term success of the Prosperity Fund. In doing so, this paper hopes to contribute to the discussion on setting up responsible savings funds by pointing out the flaws in the current implementation of the Prosperity Fund.

2 – Background Information

2.1 – Savings Funds & Rainy Day Fund

Before defining a fund, it’s important to note the distinction between a Rainy Day Fund (RDF) and a Savings Fund.  RDFs are set up by governments in order to save money during surpluses to be spent during deficits. Since borrowing money may be politically difficult (restrictions on state/province debt in the U.S./Canada), economically difficult (bond rating agencies downgrade during economic downturns), or socially difficult (cutting public services), many governments set up these funds in order to maintain the same level of government spending at all times (Joyce, 2001). Savings Fund (SF) on the other hand, are funds set aside by a government in order to store wealth during times of prosperity and generate income for the future (Davis, Ossowski, Fedelino, 2003) ; to build up a “stock of capital (be it physical capital, human capital, or foreign financial assets) that will generate income and pay for government expenditures after the natural resource is exhausted” (Luecke, 2010, 3). While most governments establish these funds as either a trust for future generations (APF) or as a stabilisation fund to be used to compensate for the volatility of government revenue (Venezuela’s Macroeconomic Stabilization Fund), some set it up for both (Oman’s oil funds) (Davis, Ossowski, Fedelino, 2003).

A well implemented SF has strict guidelines that force a substantial portion of the surplus or tax revenue into the fund while restricting withdrawals (Fasano, 2003). For example, the APF   (“What is the Alaska Permanent Fund?”,  n.d.) while withdrawals from the fund’s principal are cannot be spent without a constitutional amendment, which requires the majority vote of Alaskan citizens (Fasano, 2000).  This forces the government to save money during periods of revenue upswings rather than spend it somewhere else  (Davis, Ossowski, Fedelino, 2003).

2.2 – The BC Prosperity Fund

The BC Prosperity Fund was created by the former premier of British Columbia, Christy Clark. The stated purpose of the fund is to ensure the long term growth of British Columbia. The fund was announced in late 2013 and was met with a founding contribution of $100 million from the 2015-2016 surplus (“New British Columbia Prosperity Fund”, 2013).

The fund may be used to accomplish the following goals: (i) eliminate provincial debt, (ii) make investments in public services, and (iii) act as a fund for future generations. The fund will be allocated a portion of all revenues generated from the LNG industry such as corporate taxes as well as a portion of the surplus every year. Of the fund, 50% will be used eliminate provincial debt, with 25% remaining in the fund to generate revenue through investments and the last 25% to be used for “core government priorities in the future”  (Budget and Fiscal Plan 2016/17 – 2018/19, 2016).

As the LNG industry in BC has not met the projected growth rates, many proposed partners have elected to cancel multi-billion dollar projects  (Canadian Press, 2017). As a result, the Prosperity Fund can no longer be funded through LNG revenues.  To respond to this change, the Liberal government transferred $100 million in 2016 and 400 million in 2017 from the surplus. The recently inaugurated NDP government has made no pledges to continue the transfers in future years and made no mention of the Prosperity Fund in the 2017 September Budget Update (Budget 2017 Update, 2017).

It is extremely difficult to classify the Prosperity Fund as it has multiple sources of revenue and multiple purposes. Since 50% of the fund will be used towards debt elimination, we will interpret this as a RDF. The other 50% so far has not been used, therefore for the purposes of this paper we will assume that it will remain in the fund and generate investment revenue. Therefore the fund is a Savings Fund that will be used both for budget stabilisation and a long term trust for future generations.

3 – Methodology & Data

In order to fully assess the overall fiscal well being and the feasibility of its current construct, we first looked into the annual budgets, budget updates, budgetary outlooks announced by the Minister of Finance, and the public accounts published by the Office of the Comptroller General since the Prosperity Fund was first introduced and established.

We noticed a few gaps in our data that were either previously promised by the former Liberal government but never published, or internal government records that have not been made public. Upon the suggestion of the BC Information Access Operations, we sent a request to the Ministry of Finance requesting them to release these records to us informally. Unfortunately, they have declined to do so.

In order to enrich and further consolidate our assessment, we filed six Freedom of Information (FOI) requests to Information Access Operations for the Ministry of Finance:

• The 2017 annual progress report on the state of the BC Prosperity Fund promised by the former Liberal government.
• The terms of reference of the BC Prosperity Fund
• All records detailing the revenue and identifying the sources of revenue for the Fiscal Year ended March 31st, 2017
• Any internal guidelines or regulations from April 1, 2015 to September 11, 2017 on deciding the amounts due and/or transferred from the general fund to the BC Prosperity Fund, as reflected by – Due from the general fund – under the category of – Financial Assets – and – Inter-fund Transfer – under the category of – Revenue – on page 117 of the Public Accounts For the Fiscal Year Ended March 31st, 2017
• Any internal guidelines or regulations from April 1, 2015 to September 11, 2017 on deciding the amounts and items of expenses of the BC Prosperity Fund, and transfers from the BC Prosperity Fund to the general fund, as reflected by the category of – Expense – on page 117 of the Public Accounts For the Fiscal Year Ended March 31st, 2017
• Any internal records or interpretations on the definition of – core government priorities – specifically in the context of page 43 of Budget and Fiscal Plan 2016/17 – 2018/19. (Date Range for Record Search: From 04/01/2015 to 09/11/2017)

 

Given that our requests are still being processed, and Freedom of Information and Protection of Privacy Act (FOIPPA) grants 30 business days for public bodies to respond to our requests, we have decided to carry on with our analysis with existing records in the public realm, and update the requested information once it is made available to us.

4 – Analysis of the Prosperity Fund: Findings

4.1 – Fiscal Implications

According to the unaudited Public Accounts 2016/17 , BC Prosperity Fund’s financial and operational position currently states its net assets at $503 million (n.d., 117). The revenue includes the “inter-fund transfers” from the Consolidated Revenue Fund of $100 million in 2016 and $400 million in 2017. It also includes $3.282 million of “other revenue”, which is identified as Investment Earnings in Estimates: Fiscal Year Ending March 31, 2018. Given the lack of expenses in general of the Prosperity Fund, we can expect this investment revenue to be the deposit interest or fixed-rate bond returns. Judging from the information currently available to us, this effectively puts the annualized rate of return at 3.282% given the inaugural deposit was $100 million in the fiscal year that ended March 31, 2016.

This number is substantially lower than the effective taxpayer-supported government debt interest rate of 3.9% in 2016/17 and 4.5% in 2015/16 (Public Accounts 2016/2017, n.d., 141). This is the interest rate that the BC government pays at for the debt mainly carried for direct government operations (crown corporations excluded). There are a number of significant causes for concerns surrounding this.

In the short run, the Prosperity Fund’s rate of return is so underwhelming that directly paying off the debt will save more money than the investment revenue generated by it. Estimates 2017/18  puts the forecasted BC Prosperity Fund 2017/18 investment earnings at $5.2 million while the overall financial assets of this fund have reached $503 million (Estimates: Fiscal Year Ending March 31, 2018, 2017). The effective rate of return is therefore less than 1%. But even if this rate remains 3.282% as it was in its inaugural year, it would still be so much lower than provincial debt interest rates in the past, present and projected future (4.1% – 4.2% annualized interest rate from 2017 to 2019 (Public Accounts 2016-2017, n.d., 141))  that if the fund were to continue to be managed as it is currently, the very existence of the fund makes little sense fiscally. In 2017/2018 alone, the BC government will potentially lose from $4.1 million (if the rate of return is consistent with the 3.282% in its inaugural year) to $15.5 million (if the investment earnings match the government’s projection and the rate dips below 1%) by choosing to keep the fund over using it for immediate debt elimination. Refer to section 6.1 for numbers used.

In the long run, the cost of operating the fund still outweighs the benefit of it being an alternative to soaring debt interest rate in bad years. Let us assume that the Prosperity Fund saves up for 10 years in preparation for another Great Recession, roughly in the same time span as the years between the Asian Financial Crisis, Dot Com Bubble and the Great Recession itself.  That means the 10-year cost of keeping the fund (defined as short run costs in the last paragraph but annually compounded) will likely be larger than the cost of borrowing the same amount as the Fund for those 4 bad years. Assume a normal debt interest rate of 4.3% and a crisis debt interest rate of 5.5% (normal during the Great Recession), while the annual provincial contribution freezes at $100 million and the the fund generates a 3.3% return annually, the government will still suffer from a $16.5 million loss. It is worth noting that there is ample room for the numbers to be substantially worse than in this scenario, prompting an exponentially larger loss. Refer to section 6.2 for numbers used.

4.2 – Transparency

Information regarding the BC Prosperity Fund has not been published as promised, leading to a lack of information regarding the project. In the initial announcement, it was promised that there would be an annual report detailing the  transactions of the fund (“New British Columbia Prosperity Fund”, 2013). There has been no such report that we can find published in the last few years, and we had to file a FOI request to ask that they release the 2017 report.

Without transparency, rules can be manipulated without public knowledge. This poses a significant hurdle to the success of the fund because manipulating the guidelines allows the government to stray the fund from its initial purpose. For example, Venezuela and Oman repeatedly changed the rules that dictated the amount to be deposited into the fund. This allowed the governments to redirect capital that was supposed to go to fund towards financing government expenditures (Fasano, 2000, 19).  As a direct result, transfers to fund were very low, leading to lack of growth in the real value of the fund. In contrast, successful funds such as the APF have clear and transparent rules that allow every citizen to view exactly how much every year is transferred into the fund. Any violation of these rules is strictly prohibited since the rules are a part of the Alaskan constitution and require a majority vote by the population to change (What is the Alaska Permanent Fund?, n.d.). Therefore, the APF has been consistently funded as promised.

4.3 – Guidelines and Structure

<To be updated>

5 – Verdict

Due to the reasons mentioned above, the Prosperity Fund is poorly implemented. We have two potential fixes for this problem: (i) a complete restructuring of the Prosperity Fund or (ii) dissolving the Prosperity Fund. Given that the current BC government had promised to eliminate the Prosperity Fund, the latter seems to be the easier option.

 

6 – Calculations

         6.1 – Short term Loss

 

L = Loss in millions, I = Interest in millions, R = Revenue in millions, P = 1 yr. principal investment in millions, r1 = rate of return, r2=effective debt interest rate,

 

If r1 = 3.282%, r2 = 4.1%, P = 500

 

L = R-I = P * r2-P * r1 = 20.5 -16.41 = 4.09

 

If r1 = 1%, r2 = 4.2%, P = 500

 

L = R-I = P * r2 – P * r1 = 20.5 – 5 = 15.5

         6.2 – Long term Loss

 

L = Loss in millions over y1+y2, I1 = Regular interest in millions over y1, I2 = Irregular interest in millions over y2, I3 = Regular interest in millions over y3, R = Revenue in millions, P = 1st yr. principal investment in millions, c = annual contribution in millions r1 = rate of return, r2 = regular effective debt interest rate, r3=irregular effective debt interest rate, y1 = years of saving, y2= years of irregularity, O = The sum in the Fund at the end of y1

 

If P = 500, c = 100, r1 = 3.3%, r2 = 4.3% r3 = 5.5%, y1 = 10, y2 = 4

 

I1 – R = P (1 + (r2-r1)^y1 + c [ ((1 + (r2-r1))^y1 – 1) / (r2 – r1) ] * (1 + (r2-r1)) – P

=108.99

 

O = P (1 + r1)^y1 =1892.50

 

I2 – I3 = O (1 + (r3-r2)^y1 + c [ ((1 + (r3-r2))^y2 – 1) / (r3 – r2) ] * (1 + (r3-r2)) – O

=92.49

 

L = (I2 – I3) – (I1 – R) = 108.99 – 92.49 = 16.5

 

 

 

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