State Trust Lands Part 2: Permanent Funds

• Revenue from some nonrenewable activities on state trust lands is invested in a permanent fund, which generates investment income to support public institutions such as schools.
• Permanent fund spending is highly political and often subject to short-term thinking.
• Several states are overspending permanent funds and at least one state is spending nonrenewable resource revenue rather than investing it in permanent funds.
• As they consider investment strategies and distribution amounts, states need policies that maintain the whole trust for future generations.

State trusts have two parts: 1) state trust lands that were granted to states by the U.S. Congress when the states entered the Union; and 2) a permanent financial fund. Together these comprise the “whole trust,” which is managed to generate revenue for schools and other public institutions. The majority of states that have retained these trusts and created a permanent fund are in the West. State trust lands amount to about 51 million acres today.

The Trust Model

The value of a state trust—whether held in land or in money (that is, a permanent fund)—must be maintained in perpetuity. States receive revenues from state trust lands in several ways:

• “Renewable income” from activities such as grazing and agricultural leases, timber sales, and commercial property leases;
• “Nonrenewable income” from one-time activities that include oil and gas pumping, mining, and other mineral extraction; and
• Land sales.

To maintain the value of the whole trust for future generations, nonrenewable resource income and revenue from land sales must be deposited into permanent funds.

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Permanent Fund Policies Become Politicized

To optimize earnings on permanent fund principals, states have revised investment policies in the past three decades to invest more heavily in the stock market. Many states have increased their rates of return; however, revenue streams have become much more volatile.

For example, in the 20 years since Arizona approved permanent fund investment in stocks, it has seen great volatility in year-to-year investment returns, as the graph below shows.

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To complicate matters, states have modified their distribution policies—that is, the percentage of the permanent fund revenue that is paid out to schools and public institutions versus the percentage that is reinvested. Distribution policies are often highly political.

Recent permanent fund policy changes in several states will have serious consequences for education and land management. We have seen four types of mismanagement:

1. Distributions may be less than optimal, thereby increasing savings but distributing less to current beneficiaries.
2. Distributions may be unsustainably high, shrinking the value of the whole trust.
3. Revenue from nonrenewable resources or land sales may be diverted and spent before being deposited into the permanent fund, also shrinking the value of the whole trust.
4. Legislators may funnel permanent fund money away from K-12 education to other programs.

For example, from 2004 to 2015 Arizona distributed less than optimal amounts, prioritizing future beneficiaries over current beneficiaries. In recent years, however, Arizona has distributed more than optimal amounts, prioritizing current beneficiaries over future beneficiaries and shrinking the whole trust.

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New Mexico and Colorado have similar policies that are shrinking the value of the whole trust. Utah is currently suffering the consequences of past policies that diminished the whole trust value.

Permanency at Risk

Our research indicates that some states are failing to maintain the value of the whole trust: Arizona, New Mexico, and Colorado are over-spending from permanent funds to pay for services and avoid raising taxes; Colorado is also spending nonrenewable revenue on current needs instead of investing it in permanent funds. By treating nonrenewable revenue and the permanent fund as disposable income, the long-term value of the trust is reduced.

As the whole trust diminishes, it provides less support for education, which incentivizes further sales of land and nonrenewable resources to bridge the funding gap.

States Should Manage for Sustainability

States need an optimal distribution benchmark with legal safeguards so they can maintain the value of the whole trust for future generations. Recommendations for more sustainable management include:

• Deposit all nonrenewable resource revenue into the permanent fund.
• Distribute a stable fraction of the permanent fund every year. The fraction should match the fund’s long-term rate of return, less inflation.
• Institute legal safeguards so policies are harder to change and permanent funds are less vulnerable to politically motivated raids. Putting investment and distribution decisions in the hands of non-elected financial managers may be a solution.

Regardless of what policy or process a state chooses, the key evaluation metric is that the value of the whole trust is maintained.

Featured image of state trust land sign courtesy Tom Lane – High Country News.