Managing and Protecting Alberta’s Petro-wealth

Rising world demand for energy in the face of constrained supplies finds Canada’s major oil producer, Alberta, in the enviable position of generating huge budget surpluses from burgeoning oil revenues. How should this wealth be managed?

Disproportionate oil wealth can have a downside. The Third World is replete with examples of failed oil states, where the wealth is wasted by ruling elites living in corrupt luxuriance or by a bloated-up public sector with massive government payrolls and artificially inflated wages and salaries. The inevitable cost is a suffocated private non-oil economy that pays the cost of maintaining inefficient state service monopolies.

Alberta is certainly no Third-World basket case, but its rapidly expanding public sector is capturing a rising share of the recent increase in oil wealth. Between 1996-97 and 2005-06, a period during which Alberta’s population increased by 17% and inflation ran at 19%, provincial government spending doubled. In 1996-97 Alberta had annual interest payments of $1.5 billion. Today, its interest payments are rapidly approaching zero. Yet the savings are going into more program spending. Taken together, the government is spending 44% more per capita than a decade ago.

Alberta now spends about the most per capita on such public services as healthcare. Rather than embracing effective and tested reforms like injecting competition into the medical marketplace by buying services from competing private suppliers, it chose to put more resources into this expansive public sector monopoly. Ironically, public-sector wage inflation in Alberta’s health sector then spills over into other provinces of more limited means, which then drives calls for more federal funding and subsidies. The same happens for other public services.

As many Albertans will remember, the oil business can fluctuate widely. At some point, much like California which pumped up base spending on its public sector during the dot-com boom of the late 1990s, it is likely that Alberta will once again undergo a painful contraction of the public sector when revenues fall.

The answer to this painful cycle lies in the adoption of what former New Zealand Finance Minister Ruth Richardson calls a fiscal constitution. In 1994, she installed the Fiscal Responsibility Act, which required a high level of fiscal transparency in government. She now believes it did not go far enough and recommends the model be improved quantitively by imposing an absolute limit on the size of government, and qualitatively by insisting that all government spending achieve in fact the goals it purports to advance.

During a Calgary speech to the Frontier Centre in April, Richardson called for Alberta to introduce competitive structures in its largest spending envelopes, for health, education and social services, to ensure they are accountable, effective and responsive to public needs. “If you’re rich,” she says, “you can afford to be stupid far longer than when you’re poor.” She urged Albertans to use the opportunity presented by its resource-based windfall to squeeze underlying inefficiencies and subsidies out of current public spending.

In her opinion, spending limits are the key and one of her favourite models can be found in Colorado. TABOR, short for that state’s Taxpayer Bill of Rights, was embedded in Colorado’s constitution by a 1992 referendum. Its stated goal is to “reasonably restrain most the growth of government.” It links state spending increases to a simple formula based on population and growth and applies to all government entities in Colorado, including cities. If revenues exceed population increase plus inflation, the funds must be rebated to the public or a vote is held where the politicians ask permission to keep the extra cash.

A study of the law’s aftermath, A Decade of TABOR, details its benefits. The stability and predictability of the tax climate prompted strong economic growth. Private-sector jobs increased at nearly double the rate of government jobs. Instead of starving government, these consequences allowed it to spend more in tandem, at a per capita growth rate of 72% over the decade. Between 1997 and 2001, TABOR’s rebate mechanism returned US$3.25 billion in surplus revenues to taxpayers. When other state governments faced recession and collapsed revenues in 2000, Colorado largely sailed through.

Had such a fiscal constitution been operating in Alberta, resource constraints on the public sector would have led to more policy innovation, particularly the introduction of competition into public services. In addition, according to calculations by the Canadian Taxpayers Federation, by limiting spending growth to population increase plus inflation the province would have had room to eliminate the provincial income tax. Both scenarios scare other provinces, also mired in old policy models and fearful of tax competition.

One way to address these concerns is to commit the revenues above population growth and inflation into an Alberta version of the Alaska Permanent Fund, an endowment fund which operates at arm’s length from the state government, run by independent managers who are obliged to follow the “prudent investor rule”: seeking the highest return with no consideration of social or political goals. Ten-and-a-half percent of its earnings, averaged over five years, go directly back to citizens, who exercise direct control over the distribution of the fund’s earnings. If the state government wants to spend more, it must put the matter to a vote. Like the fiscal constitution, this fund is designed explicitly to prevent the excessive capture of oil wealth benefits by politicians and public sector interest groups.

Lastly, Alberta’s wealth is exposed to danger from other provinces. Ottawa is facing pressure to increase equalization transfers to “have not” provinces, which discourage investment there and create provincial-scale welfare traps with uncompetitively high levels of taxes and government spending. Alberta needs to support aggressive reform to equalization. It might commit, for example, to co-investing with the federal government in a one-time buyout of the subsidy stream, whereby debt is transferred to the federal government in exchange for the end of transfer payments.

In short, to preserve its resource wealth Alberta must make sure it ultimately ends up in the hands of the private, not the public sector.

This article originally appeared in the Fall, 2005, edition of Dialogues, published by the Canada West Foundation.