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Energy Rainy day fund: It’s not Texas’ first rodeo with falling oil prices

Rainy day fund: It’s not Texas’ first rodeo with falling oil prices

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While the diversified state economy continues to grow, one area that will continue to feel the pains of lower oil prices will be the state treasury. Texas greatly benefitted from the oil boom through revenue from natural gas and oil production taxes, which equal 7.5 percent of the market value of natural gas and 4.6 percent of the value of oil production in the state. Sales taxes, motor fuels taxes, and many other sources of funds tend to rise with the price and production of oil.

Revenue from these taxes peaked at $4.6 billion in 2014, which was 9.4 percent of general revenue for that year. (These statistics are based on the state’s fiscal year, which runs from September 1 to August 31.) From fiscal year 2010 to 2014, the natural gas and oil production tax revenue grew at an average of 27.2 percent and 40.0 percent annually.

However, as oil prices dropped in 2015, associated tax revenue also fell to less than $4 billion for fiscal year 2015 (only 7.9 percent of general revenue). In fiscal year 2016, revenues fell even further, with tax revenue of just $1.7 billion from oil production and only $579 million from natural gas. All in all, the Comptroller’s office had to reduce its revenue estimate for fiscal years 2016 and 2017 by $2.7 billion, due in large part because of lower oil and gas tax collections and related sales tax revenue.

This episode is not the state’s first experience with rollercoaster tax revenue from oil and gas. In the aftermath of the oil downturn of the 1980s, the state had to raise taxes and cut funding in many areas to cover the shortfall when the energy-dominated economy went downhill. To help avoid future problems, the Texas Legislature created a safety net in the form of an economic stabilization fund (ESF), commonly referred to as the “rainy day fund.” The fund was designed to set aside tax revenues during boom years in order to have funds available for any subsequent drops in oil and gas activity (like we have today).

All but four states use an ESF, but with a balance of nearly $9.7 billion, Texas now has the largest (passing up Alaska in fiscal year 2016). The idea is that with conservative budgeting and fiscal management, the use of the ESF will allow the state to meet cash flow needs without having to borrow money or raise taxes in lean times, which is a normal practice for many other states as well as what was typical for Texas for much of the past three decades.

More than 85 percent of funding for the ESF comes from oil and gas production taxes, with the remainder from a share of any uncommitted balances in the state’s general revenue at the end of each 2-year session. Originally, the fund received 75 percent of each year’s oil and gas production tax revenue in excess of the revenue received in 1987 ($531.9 million for oil and $599.8 million for gas). In 2014, a constitutional amendment diverted half of the ESF’s share of the oil and gas tax revenues to the State Highway Fund for transportation needs. Even with only receiving half of its original share, the ESF grew an estimated $1.2 billion in fiscal year 2015 after the state yielded close to $4.2 billion in oil and natural gas production tax revenue. In November, the fund will receive another $439.5 million.

Over the course of the fund’s lifetime, the ESF has received $19.5 billion in deposits and has earned another $789.9 million in interest. The Legislature can make appropriations from the ESF to cover a current budget deficit or a projected revenue shortage with three-fifths approval, but that has only happened once (in 2011, when $3.2 billion was used to cover a budget gap). The Legislature can also make appropriations for any other purpose with the approval of two-thirds of the body, and six appropriations of this nature have been made for purposes including water projects, disaster relief, public education, economic development, and health and human services. Overall, the Legislature has approved appropriations totaling $10.6 billion since the fund’s inception.

Even with appropriations in the 1990s that nearly wiped out the balance of the fund multiple times, the recent oil surge has provided a substantial nest egg. While the state constitution sets a maximum balance for the fund at 10 percent of the general revenue received during the previous biennium, the ESF balance has never approached the cap. Also, the 2014 amendment stated that the ESF must have a “sufficient fund balance” but it is not specified what that should be in any amendment or law. Instead, a committee determines what the sufficient balance should be prior to each legislative session and it is currently set at $7 billion for the 2016-17 biennium.

With the state facing slowing revenue growth due to the slack oil and gas industry activity, whether and how to use the available funds in the ESF will be a major topic up for debate in the upcoming legislative session. Funding challenges range from redesigning the foster care system to funding various pensions to education and infrastructure needs. In recent years, lawmakers were able to spot rain about as often as West Texans during the recent drought.

Without a rise in oil prices, large spurts in funding for the ESF are going to be scarce (the natural gas production tax revenue did not even meet the threshold to be able to contribute to the ESF in fiscal year 2016). However, these are the rainy days that the ESF was originally created for, and there is a clear argument for using some of the huge available balance to meet the pressing needs of a vibrant state with enormous growth potential.

___________________________________________________________________

Dr. M. Ray Perryman is president and CEO of The Perryman Group (www.perrymangroup.com). He also serves as Institute Distinguished Professor of Economic Theory and Method at the International Institute for Advanced Studies.

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