commentary_263

C.D. Howe Institute

COMMENTARY

Greater Saving Required:How Alberta can Achieve Fiscal Sustainability from its Resource Revenues

Leslie ShiellColin Busby

In this issue...How much to set aside? Alberta needs to set aggressive savings targetsfor its resource wealth if it is to achieve intergenerational equity andfiscal sustainability.

NO. 263, MAY 2008

FISCAL POLICY

The challenges that come with an abundant supply of resource wealthpresent difficult fiscal decisions for the Alberta government. One highlypublicized concern is the need for the province to devise a long-run plan forresource revenue savings. This study focuses on the appropriate measuresthat fiscal planners must take to ensure the province's long-term fiscalsustainability. The study uses a forward looking model, taking into accountthe resource revenues Alberta can expect from its energy future, and targetsthe equal distribution of government spending from resource wealth acrosscurrent and future generations of Albertans. The results of the model arecompared against the province's current ad-hoc budget rules to illustrate thefiscal consequences of spending too much resource wealth upfront and notsaving enough for generations to come.

We find that Alberta's current annual level of savings should be even moreaggressive than the Norway standard. The province should amalgamate itssavings funds; broaden the debate on the true impact of resource wealth onannual budgets – through personal and corporate income taxes in additionto royalties and leases – and aim to distribute the province's per capitaspending from resource wealth equally over time.

ABOUT THE INSTITUTE

The C.D. Howe Institute is a leading independent, economic and social policy researchinstitution. The Institute promotes sound policies in these fields for all Canadians throughits research and communications. Its nationwide activities include regular policy roundtablesand presentations by policy staff in major regional centres, as well as before parliamentarycommittees. The Institute's individual and corporate members are drawn from business,universities and the professions across the country.

INDEPENDENT • REASONED • RELEVANT

THE AUTHORS OF

THIS ISSUE

LESLIE SHIELL ISASSISTANT PROFESSOR,DEPARTMENT OF

ECONOMICS, UNIVERSITY

OF OTTAWA.

COLIN BUSBY ISPOLICY ANALYST, C.D. HOWE INSTITUTE.

Rigorous external reviewof every major policy study,undertaken by academicsand outside experts, helpsensure the quality, integrityand objectivity of theInstitute's research.

$12.00; ISBN 0-88806-739-9 ISSN 0824-8001 (print);ISSN 1703-0765 (online)

THE STUDY IN BRIEF

Alberta has enjoyedunprecedented prosperitythanks to the recent run-up in

oil and natural gas prices. Between1999 and 2006, direct resourcerevenues accruing to the governmentincreased 152 percent, programexpenditures increased 80 percentand the government paid off alloutstanding debt.1

Nonetheless, this state of affairs rests on aprecarious foundation of volatile revenues froman exhaustible resource base. For this reason,many Albertans are asking whether the provincehas saved enough for the future. This questionhas taken on particular importance in light ofrecent media reports about the successful exampleof Norway, an oil-rich country that places moreemphasis on saving its resource revenues thanAlberta.2 In order to address these concerns, wewill focus in this Commentary on the followingfour questions:

• Has Alberta saved enough to date?• What level of spending out of resource wealth

is sustainable, moving forward?• What are the implications of such a

sustainable policy for provincial budgetplanning?

• Should Alberta follow Norway’s example?

To answer these questions, policymakers mustfirst identify the principles that should guidefiscal policy over the long run. In recent years, theconcept of sustainability has emerged as one suchprinciple.

Economists define fiscal sustainability in termsof the Permanent Income Model, first proposedby Milton Friedman in the 1950s. In recentyears, researchers working at the International

Monetary Fund have adapted this model forresource-rich jurisdictions in a version we call thePermanent Resource Income Model (PRIM). Insimple terms, PRIM identifies the highest level ofannual government spending that can be financedindefinitely from resource wealth, given what isknown and expected about the resourceendowment.

We argue that this level should be calculated inper capita terms in order to balance competingobjectives of intergenerational equity, economicefficiency and fiscal prudence. The model dealswith the eventual exhaustion of the resource baseby building up sufficient financial wealth toprovide an alternative stream of future income.

Applying the model to Alberta yields thefollowing answers to our four questions:

• Alberta has, in fact, saved more than enoughto date compared with a hypotheticalsustainable policy implemented at thebeginning of oil and gas exploitation in 1948.

• Notwithstanding this positive result, theprovince must now begin an aggressive savingspolicy if it wishes to sustain a constant level ofper capita expenditure in the future. Inparticular, given our reference forecast offuture revenues, the government must aim tosave an amount equal to 139 percent of directresource revenues over the next five years.Failure to meet this target will lead to apermanent decline in fiscal capacity thiscentury, as the resource base and revenuesdiminish.3

• Alberta’s Fiscal Responsibility Act provides forless than half the savings called for during thenext five years, and its relative performancewill deteriorate beyond that point. Whilefurther increases in resource royalties mayhelp, our analysis suggests that the governmentwill also have to undertake a combination of

Commentary 263 | 1

Independent • Reasoned • Relevant C.D. Howe Institute

The authors would like to thank Finn Poschmann, Robin Banerjee, Bev Dahlby, Yvan Guillemette and Maciej Kotowski for their helpfulcomments on earlier drafts.

1 Figures based on data from Alberta (2007).

2 See, for example, Saunders (2008) and Scoffield (2006).

3 Our forecasts show the resource base being depleted in 2095.

spending cuts and increases in non-resourcetax levels.4

• The Permanent Resource Income Model isconceptually different from the approachfollowed by Norway. In particular, whilePRIM seeks to equalize per capita spendingover time, the Norwegian approach containsan explicit bias in favour of future generations.Nonetheless, under present circumstances,PRIM actually calls for Alberta to save morethan the Norwegian approach, not less.

Beyond specific targets and values, PRIMprovides the ground rules for a process ofsustainable fiscal planning that any jurisdictioncan follow. At its centre is the idea thatgovernment expenditure based on resource wealthshould be smoothed out over time so that allcitizens share equally in the resource bounty.

In contrast, current debates over resource-wealth spending usually revolve around thegovernment’s short-term record. In this vein,Alberta has in recent years legislated fiscal rules toeliminate deficits and constrain the budgetingprocess.5 While these rules have proven useful asstatements of the government’s budgetingpriorities, they are, in general, too ad hoc toprovide long-lasting guidance on fiscal policy.Indeed, their history is one of constant revision asnew developments render yesterday’s rulesobsolete. Unfortunately, repeated revisions haveled to increased complexity, including aproliferation of savings funds. This complexityhas reduced the transparency of the budgetingprocess and does not serve Albertans well.

The Permanent Resource Income Model,however, provides a comprehensive and clearframework for guiding long-term fiscal policy.The model supersedes all other fiscal rules. It alsocalls for the consolidation of Alberta’s various

savings funds, thus increasing the transparency ofthe budgeting process and the public accounts.

Fiscal Sustainability

The debate over managing resource revenuesrevolves around the following key questions: howmuch should be saved in any given year? and howmuch should be spent for the immediate benefitof citizens (i.e. program spending)? By saving, wemean payment of interest or principal, if thegovernment is a net debtor, or accumulation offinancial assets, if it is a net creditor.6

We interpret sustainability to mean that a givenpolicy can be continued at the current levelindefinitely. It follows that sustainability requiresa shift of focus from the short term to the longterm. Short-term thinking about fiscal policyrevolves around the current budget balance. Incontrast, long-term thinking focuses upon thegovernment’s total wealth — in particularwhether this wealth is adequate to support a long-term fiscal plan of which the current budgetbalance is only one element. For this purpose, thegovernment’s total wealth consists of twocomponents: its financial position (the differencebetween assets and liabilities); and the presentvalue of future revenue streams.

Economists interpret fiscal sustainability interms of the Permanent Income Model of budgetplanning, originally developed by Friedman(1957). Permanent income is defined as theannuity value of total wealth. In effect, it is as ifthe government could invest its total wealth(including the rights to future streams of revenue)in the bond market and receive an annual returnon the investment. Permanent income indicatesthe amount that can be spent in a year consistentwith maintaining total wealth constant.7 Spend

| 2 Commentary 263

C.D. Howe Institute

4 Our estimation of the sustainable benchmark already takes into account the increases in royalty rates announced following the 2007 AlbertaRoyalty Review Panel.

5 See Kneebone (2006) for a history of such rules in Alberta.

6 We include debt interest payments in the saving envelope, although it is conventional to account for them as current expenditure. Interestpayments represent a transfer from taxpayers to bond holders and thus do not provide a net benefit for society in the period in which they aremade.

7 In fact, following Engel and Valdes (2000), what we have here is a special case of the Permanent Income Model in which the agent’ssubjective discount rate is equal to the (exogenous) real interest rate.

more than this amount and wealth will fall; spendless and wealth will grow. Thus permanentincome corresponds with the maximum annualspending level that can be maintainedindefinitely, assuming nothing changes.

When assessing fiscal sustainability forresource-based economies, economists typicallynarrow the focus of the model to resource-basedwealth only; i.e., financial assets plus the presentvalue of future resource revenues.8 For thispurpose, we denote spending from resourcewealth9 as GR. We take the view that allAlbertans, including those yet to be born, areentitled to an equal share of resource-basedspending. Therefore, we define fiscalsustainability in terms of the maximum constantvalue of GR per capita. By definition, this value isequivalent to permanent resource income percapita, which is the annual return on per capitaresource wealth.

In a given year, resource revenue may be lessthan or greater than GR. If less, then thedifference is covered by either investment incomeor borrowing. If greater, the surplus is savings.The role of borrowing springs from the fact thatresource revenues do not, in general, flow at aconstant rate. In particular, if revenues start outlow at the beginning of extraction and increaseover time, the Permanent Resource IncomeModel entails borrowing against future revenuesat the outset, then paying off the debt andbuilding positive wealth later when revenues aregreater. This way, all generations can enjoy thesame level of spending per capita from theresource base, despite variations in the revenueflow. In the long run, it is important to buildsignificant financial wealth to provide a base forcontinued spending once the resource base isexhausted. Thus, over time, the flow of resourcerevenue is replaced by a flow of investmentincome, as in-ground wealth is converted intofinancial wealth.

This blending of borrowing and saving isanalogous to household financial planning. Whenincome is temporarily low, the household mayborrow against future earnings; when income isunexpectedly high, the household may save thesurplus. And, ultimately, the household willprobably wish to accumulate adequate financialwealth to provide for spending during retirement.In this context, debt is not a bad thing, because itis manageable within a long-term plan.

There are, however, other perspectives on fiscalsustainability. Tersman (1991), for one, definessustainability in terms of a constant ratio of GR

to non-resource GDP. Assuming non-resourceGDP grows over time, this rule entails that GR

grows at the same rate. Further, if non-resourceGDP grows faster than the population, it followsthat GR must also grow faster than thepopulation. While such growth may seemattractive, it comes with a price. In particular,compared with the constant path we propose, GR

per capita in Tersman’s framework must start outlower, with more of the resource revenue saved inevery period. Consequently, this growth in GR

per capita benefits future generations at theexpense of early generations. In light of the factthat future generations will also benefit fromhigher non-resource GDP per capita in thisscenario, we see no ethical basis for skewingresource-based spending in their favour as well.

Engel and Valdes (2000) point out that evenconstant GR per capita may be too generous forfuture generations since, as mentioned, they willlikely benefit from higher non-resource GDP percapita. With this in mind, they propose thatresource wealth be used to compensate earliergenerations for lower non-resource incomes. Thisapproach entails a declining path of GR per capita.10

Fiscal policy must also take into account theimpacts of taxation and uncertainty. A constantor declining path of GR per capita must beaccompanied by an increasing path of non-

Commentary 263 | 3


8 See, for example, Tersman (1991), Liuksila et al. (1994), Davoodi (2002) and Barnett and Ossowski (2002).

9 We use spending out of resource wealth, resource-based spending, resource spending and resource expenditure synonymously.

10 Engel and Valdes present two such models. The first is a full application of the permanent income approach, in which the government uses taxesand transfers to achieve a constant level of total spending (private plus public) per capita over time. In the second, which they call the“conditionally normative model,” the government does not touch the intergenerational distribution of private spending (consumption in theirvocabulary), but rather uses resource revenues to top-up the spending of early generations, because they are poorer in terms of private spending.

resource tax rates if, as expected, the per capitademand for public goods grows in step with percapita GDP. Such increases in tax rates have a costin terms of greater economic distortion.Economists argue that stabilizing tax rates overtime — a condition known as “tax smoothing” —can minimize the distortionary cost of taxation.11

But stabilizing tax rates would require a constantGR/GDP ratio, rather than constant or decliningGR per capita.

Uncertainty complicates fiscal planning further.The Permanent Resource Income Modelgenerates a prescription for a constant level ofresource expenditure, provided nothing changes.In reality, however, most of the relevant factors,including resource prices, extraction rates, costsand reserve size have proven to be quite volatileover time. Applied research uses a “certaintyequivalent” approach, in which expected values ofvariables are treated as certain values in thesolution of the model, and no other adjustmentsfor uncertainty are made.12 This approach isfollowed here. However, theoretical researchindicates that risk-averse agents respond touncertainty by saving more than the certaintyequivalent level, a phenomenon referred to as“precautionary saving.”

To summarize, we have identified threearguments for deviating from our rule of constantGR per capita. First, the equity argument: sinceearly generations will likely be poorer than futuregenerations, we should skew GR in the theformer’s favour. Second, following the theory oftax smoothing, we should maintain a constantGR/GDP ratio to keep tax rates constant andminimize related distortions. In contrast to theequity argument, this approach calls for skewingGR in favour of future generations. Third,precautionary savings requires more saving andless spending than certainty equivalence, thusskewing GR in favour of future generationscompared with our rule.

Accounting formally for these three argumentsis beyond the scope of this Commentary.

However, we note that our model’s deviation onthe first item is opposite to its deviations on thesecond and third items. Thus, the deviations maybe at least partially offsetting. Further, we notethat Alberta’s tax system is among the leastdistorted in Canada, with flat tax rates of 10percent on both personal and corporate incomeand no provincial consumption tax.13 Thus, theargument for tax smoothing may be weaker forAlberta than elsewhere. Since equity andefficiency are pulling policy in opposite directionshere, a rigorous approach would require findingan optimal balance, which of course would liesomewhere in the middle. It is possible that ourconstant GR per capita rule may not be far off.

Finally, we note that, as a practical matter,uncertainty of future variables means that regularrevisions of the fiscal plan will be necessary asnew information becomes available. At a givenplanning date, the permanent income approachyields a prescription for a constant level ofresource-based spending based on expected valuesof variables and assuming nothing changes. Butof course conditions do change. In every planningperiod (e.g. next fiscal year), the exercise will needto be repeated, using realized values for theelapsed period and updated forecasts of futurevariables. In light of these changes, the prescribedlevel of resource spending would change as well.Thus, in retrospect the amount of per capitaresource spending would be variable, while in anygiven year the plan would call for a constant valuemoving forward.

Historical Perspective:Has Alberta Saved Enough?

An essential part of the debate over resourcemanagement in Alberta concerns whether pastgovernments have saved enough to provide forfuture generations once resource stocks run out.This question reflects a widely held belief, or atleast suspicion, that too much of the finiteresource wealth has been spent to date and not

| 4 Commentary 263

C.D. Howe Institute

11 Blanchard and Fischer (1989, 583-589) provide a discussion of the related literature.

12 See Tersman (1991), Liuksila et al. (1994) and Davoodi (2002) for examples of this approach.

13 See Chen, Mintz and Tarasov (2007).

enough saved.14 This concern has been fuelled bynumerous stories in the press (e.g. Scoffield 2006,Saunders 2008) comparing Alberta’s approachwith that of Norway, which places a greateremphasis on saving.15

This question appears to be backward looking,as it concerns whether governments have madeappropriate decisions in the past. However, uponexamination, it is apparent that one cannotanswer this question without also taking intoaccount probable conditions in the future. Oneneeds a roadmap of where Albertans want to go— or more precisely a statement of what futurecitizens have a right to expect— in order to assess whetheradequate provisions have beenmade in the past. ThePermanent Resource IncomeModel provides such aroadmap.

For this purpose, we suggest a “perfectforesight” approach, in which past values aretaken as given and forecast values are assumed tobe certain. This approach amounts to a thoughtexperiment, in which spending and savingdecisions are retrospectively calculated from 1948through to the end of extraction, following themodel.16 Of course, the government of Albertawas not in this position in 1948, since it mostcertainly could not foresee the paths of prices,reserves, extraction and other variables.Nonetheless, one can ask whether by accident thegovernment saved as much as prescribed by thishypothetical scenario.

As described previously, the task is to calculatethe annuity value from the government’s totalwealth, which consists of current financial assetsplus the present value of future resource revenues.

Estimating future resource revenues requiresforecasts of key variables, including resourceprices, reserves, extraction rates, royalties, interestrates, inflation and population. We have basedour forecasts on the leading authorities in thefield, including the International Energy Agency(IEA), the Energy Information Administration(EIA) of the US Department of Energy, theCanadian Association of Petroleum Producers(CAPP) and others. We consider high, mediumand low forecasts associated with these variables.The medium case is the most likely, and we referto it henceforth as the reference forecast.

(Appendices A and B describethe data we use and themechanics of the PRIM.)

Based on the PRIM, weestimate that, under thereference forecast, a perfectlyforesighted planner would have

fixed GR at a constant value of $3,576 per capita,starting in 1948, and would have carried a netdebt of approximately $74 billion at thebeginning of the 2007/08 fiscal year.17 Incontrast, the province managed a positive netfinancial holding of $35.7 billion by that year.Thus, we conclude that Alberta has saved morethan enough of its resource wealth to date,compared with our benchmark.

The high level of debt prescribed under“perfect foresight” for 2007 results from theunequal flow of resource revenues over time.Figure 1 presents the paths of total resourcerevenues, budget balances under perfect foresight(PRIM) and actual budget balances for theplanning horizon 1948-2095.18 As shown, mostof Alberta’s resource revenues are expected to berealized after 2005.19 Thus, our hypothetical

Commentary 263 | 5


14 For many expressions of this point of view, see the submissions to the Alberta Royalty Review Panel at www.albertaroyaltyreview.ca

15 We provide a detailed analysis of Norway’s approach later in the paper.

16 See Tersman (1991), Liuksila et al. (1994) and Davoodi (2002) for examples of this approach.

17 Except where noted, all monetary values are in 2007 dollars.

18 We are referring here to the consolidated budget of the province, including all saving funds. This version differs from the common notionof the government’s budget, which corresponds with the General Revenue Fund. Note our numbers for the actual budget balance (asopposed to PRIM) only cover the sub-period 1981-2007.

19 As the figure presents nominal values, inflation accounts for some of this skew in the flow of revenues. Of course, inflation works to theadvantage of debtors as it erodes the value of debt principal. The brief decline and recovery of revenues during 2026-2031 reflects theforecast exhaustion of conventional oil and natural gas in 2026, followed by the forecast peak in revenues from the oil sands in 2031.

Alberta has saved morethan enough of its resourcewealth to date, compared

with our benchmark.

| 6 Commentary 263

C.D. Howe Institute

Figure 2: Revenue and Savings (forecast vs. required)

Source: Author’s calculations using reference forecast.

$C n

omin

al (

mill

ions

)

Figure 1: Revenue and Savings

Source: Authors’ calculations based on reference forecast; Alberta Budget Documents.

$C n

omin

al (

mill

ion)

1948 planner borrows against future earningsuntil 1999 (with minor exceptions), in order tofinance spending in these early years. Then, from2000 to 2013, the planner pays off debt. Finally,the planner begins to accumulate net wealth in2014.20 In contrast, the actual experience of theprovince to date has involved more frequentsurpluses, as evidenced by the positive value ofnet wealth in 2007 ($35.7 billion) and by theactual budget balance series shown in the figure(1981-2007 only).

Looking Forward: a SustainablePolicy for Resource Revenues

The fact that Alberta has accumulated morewealth to date than required under the “perfectforesight” scenario allows it to sustain a moregenerous level of GR per capitamoving forward. Starting in2007/08, based on netfinancial wealth of $35.7billion, the model returns aGR value of $4,501 per capitain the reference case (roughly$900 more per capita than forthe historical perspective).

This plan requires asignificant increase in the government’s savingsrate starting immediately, notwithstanding itssuperior performance in the past. To illustrate,Figure 2 compares resource revenues during thefive years from 2007-2011 (reference forecast)with the budget surpluses required by the model(“PRIM required savings”), and with the forecastbudget surpluses under current fiscal rules (“FiscalResponsibility Act — forecast savings”).

Figure 2 presents both total and direct resourcerevenues. As explained in Appendix A, we classifyresource revenues as direct, indirect or diversified.Direct revenue is equivalent to the line itemlabelled “resource revenues” in the public

accounts, which includes royalty taxes, Crownland leases, rentals and fees. Indirect revenuecorresponds with all other tax revenues generatedby oil, gas and related sectors in the province —for example, corporate and personal income taxes.Diversified revenue corresponds with taxes paidby upstream and downstream firms that havediversified away from reliance on the domestic oiland gas sector. For example, firms that started byservicing the oil and gas sector may eventuallyfind clients outside the province or in unrelateddomestic sectors. Although no longer generatedby domestic oil and gas activity, these revenuesare still classified as resource revenues since theywould not have come about without the impetusprovided by the resource sector.

As shown in Figure 2, the required savingsunder PRIM exceeds direct resource revenues by a

significant margin. Inparticular, for the five years2007-2011, the cumulativesurplus under PRIM amountsto 53 percent of total resourcerevenues and 139 percent ofdirect revenues — i.e., morethan one-third greater than thecumulative value of resourceroyalties, land leases, rentals

and fees. Furthermore, these proportions are setto increase progressively beyond the dates shownin the figure.

The Fiscal Responsibility Act of 2007 (FRA)establishes the province’s current policy towardsaving. Under the FRA, the first $5.3 billion ofdirect resource revenues are to be allocated tocurrent spending, with the remainder saved.Figure 2 shows the estimated size of theremainder based on our reference forecast ofresource revenues.21 For the five years shown,cumulative savings under FRA amount to only36 percent of the level prescribed by PRIM(alternatively, 48 percent of direct resource

Commentary 263 | 7


20 The series on net wealth is not shown in the figure.

21 As well, extra savings could come from unbudgeted surpluses. Thus, the values presented in Figure 2 represent a minimum expected level ofsavings under the FRA. However, we note that the In-Year Surplus Allocation Policy requires two-thirds of unbudgeted surpluses to beallocated to the Capital Account — in other words, on spending rather than saving. Also, the Sustainability Fund is currently not requiredto retain all deposits legislated by the FRA and can direct funds towards capital projects. This reduces the expected level of savings underthe FRA.

This plan requires asignificant increase in thegovernment’s savings rate

starting immediately,notwithstanding its superior

performance in the past.

revenues). We conclude, therefore, that thecurrent savings commitment is insufficient tomaintain a constant level of GR per capita in thefuture, under the reference forecast. Thisconclusion is supported as well under high andlow forecasts of the variables as shown inAppendix C.

We can also forecast the effect of the FiscalResponsibility Act over the long term (Figure 3,reference forecast). Initially, the lower savings rateunder the FRA produces higher GR per capitathan the PRIM benchmark, but the spendinglevel declines steadily. By 2034, resource spendingunder the FRA falls permanently below thebenchmark. By 2095, when the resource base isexhausted, the spending level under the FRA isonly 25 percent of the PRIM benchmark. Thislevel is sustained thereafter by interest onaccumulated savings and by the flow of diversifiedrevenues (assumed constant after exhaustion).22

By 2068, direct resource revenues (not shown) fallpermanently below the $5.3 billion threshold,and no further saving of resource revenues isundertaken under the FRA. At this point, weassume the government would adopt a minimalistwealth preservation strategy by saving enough ofinvestment income every year to inflation-proofthe accumulated fund. The remainder ofinvestment income under this strategy is spent.

Figure 3 highlights the choice Albertans mustmake between a sustainable policy of resource-based spending and the current policy thatfavours present over future generations. Wesummarized earlier the debate among economistsover skewing resource expenditure in onedirection or another (the equity argument versustax smoothing and precautionary savings).Following Engel and Valdes (2000), one couldjustify the FRA policy on the basis of equity,provided that non-resource GDP per capita grew

| 8 Commentary 263

C.D. Howe Institute

Figure 3: Resource-based Spending under PRIM and the Fiscal Responsiblity Act

4,5014,501

1,116

6,312

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 2055 2060 2065 2070 2075 2080 2085 2090 2095 2100

PRIM FRA

Source: Authors’ calculations using reference forecast.

$C (

2007

) pe

r ca

pita

22 In the absence of diversification, the long-run expenditure level would be lower under both PRIM and the FRA.

in an offsetting fashion. However, as discussed,tax smoothing and precautionary savings pullpolicy in the opposite direction.

Moreover, while non-resource GDP mayindeed grow in the future, it is doubtful that itwill grow quickly enough to fully compensate forthe decline in GR under the FRA. We forecastthat decline at an average annual rate of 1.88percent (real) in the reference case. Given thedifference in size of the resource and non-resourcesectors, it is likely that non-resource GDP wouldhave to grow faster than 1.88 percent to fullyoffset the lost resource revenues. For example, forthe 25-year period from 1981-2006, we estimatethat Alberta’s resource-based GDP was on average35 percent larger than its non-resource GDP.23 Itfollows that the annual growth rate of non-resource GDP per capita would have to be 35percent larger than this decline rate — i.e., 2.54percent. Yet the average real growth rate of non-resource GDP per capita in Alberta during thisperiod was only 1.2 percent per annum.24

Moreover, this rate is set to erode as the labourforce participation rate drops with the aging ofthe population. Thus, there is ample reason todoubt that non-resource growth could fullycompensate for the decline in GR entailed by theFRA.

Over the three years from 2007-2009, we forecastthe shortfall of planned savings under the FiscalResponsibility Act compared with the benchmark inour reference model will average $8.8 billion peryear ($2007) — an amount equivalent to 26percent of total expenditures planned for this periodin Budget 2007. Part of this gap could be coveredby unbudgeted surpluses, but part wouldundoubtedly have to be made up by eitherreductions in current expenditures, increases in

resource tax rates or increases in non-resource taxlevels.25

Resource tax rates include royalty rates (directresource revenues) as well as personal andcorporate taxes on income earned in the sector(indirect resource revenues). While increasingthese rates would generate more revenue ifnothing else changed, in reality it would alsoproduce a number of offsetting effects. First,higher resource taxes would boost thegovernment’s wealth by increasing the presentvalue of future resource revenues. As a result, theprescribed level of GR per capita would increaseas well. This change would require either more orless saving, depending where the government wasat in the borrowing/saving cycle of the model(less saving early on, more saving later). Second,increasing resource taxes would have a dampeningeffect on activity in the sector, an effect that washotly debated during the recent royalty review inthe province.

While accounting for these effects explicitly isbeyond the scope of the paper, we haveconducted sensitivity analysis on the effect ofhigher royalty rates, holding everything elseconstant.26 Our results indicate that whileincreasing royalty rates (increasing prices) doesreduce the savings gap (111 percent of directrevenues versus 139 percent), it does not comeclose to eliminating it. Therefore, we expect thatthe government would also have to pursuereductions in expenditures as well as increases innon-resource tax rates to close the savings gap.

The prescribed policy provides a level of percapita expenditure based on resource wealth thatcould be sustained indefinitely if the forecastproved to be true. The key to sustainability is thegradual replacement of resource revenues withincome from accumulated savings. Figure 4

Commentary 263 | 9


23 We focus on private GDP; i.e., net of government expenditure. Mansell and Shlenker (2006) estimate resource activity accounts forapproximately 50 percent of Alberta GDP.. Therefore, multiplying GDP values (Statistics Canada, CANSIM V3839827) by 0.5 andsubtracting total government expenditure (Alberta budget documents) yields private non-resource GDP.

24 In neighbouring British Columbia, the growth rate for total GDP per capita during this period was even lower, at 0.9 percent per annum(real). Statistics Canada, CANSIM V3839831.

25 Our reference forecast already makes provision for the announced increases in resource royalties in response to the Alberta Royalty ReviewPanel.

26 The results of the sensitivity analysis are presented in Table C1, Appendix C. We model an increase in resource royalty rates as equivalent to anincrease in resources prices holding royalty rates constant.

illustrates this replacement process for thereference forecast. Initially, investment incomeamounts to only a few hundred dollars per capita,while resource revenue amounts to more than$7,000. By 2048, the two amounts are equal. Bythe end of our horizon, investment incomeaccounts for approximately 86 percent of the totalvalue of GR per capita ($4,501). The remaining14 percent ($633) consists of diversified resourceincome, which we assume continues at a constantlevel after the exhaustion of the resource base.27

The Bird-in-the-Hand Approach: Should Alberta Follow Norway’sExample?

Much discussion in recent years has focused onwhether Alberta should follow Norway’s exampleof saving a larger share of its resource wealth.28

Bjerkholt and Niculescu (2004) refer to this as

the Bird-in-the-Hand approach (BIH), because itdoes not treat resource revenue as part of thegovernment’s wealth until the resource isextracted and the revenue is realized. In thisapproach, the government’s wealth consists solelyof current financial assets. Resource revenues areto be saved in a fund, and only the income on thefund is made available to the government forspending in its annual budget.

Norway began managing its oil revenues in thisfashion in 1991. Since then it has accumulated$368.2 billion in its saving fund, equivalent toapproximately $78,000 for every Norwegian(Saunders 2008). Current legislation permits anannual transfer of four percent of the equity forspending in the government’s budget, equal to theaverage expected rate of return of the fund(Bjerkholt and Niculescu 2004). At present,approximately 10 percent of the government’sbudget comes from this source (Saunders 2008).

| 10 Commentary 263

C.D. Howe Institute

Figure 4: Sources of Resource-based Income


$C (

2007

) pe

r ca

pita

27 Prior to exhaustion in 2095, the sum of resource revenues and investment income exceeds the value of GR per capita by the amount of savings(total budget surplus). In our low variant of the forecast, diversified revenues are zero and investment income equals 100 percent of GR afterexhaustion. See Appendix C for the presentation of the various forecast scenarios.

28 See for example Saunders (2008), Scoffield (2006) and ARRP (2007).

Alberta also has a vehicle for saving resourcewealth, the Alberta Heritage Savings Trust Fund— commonly referred to as The Heritage Fund.Established in 1976, it grew to $12.7 billion by1987, but no further deposits were made until2005. It now stands at $16.6 billion, orapproximately $4,900 per Albertan (AHST 2007,2008 and Statistics Canada). In contrast, since1976, the province has received a total of $148.1billion in direct oil and gas revenues and anestimated $330.7 billion in total revenues (direct+ indirect + diversified). During the same period(1976-2007), direct oil and gas revenues (net ofdeposits into the Heritage Fund) accounted for29 percent of current government spending,while total revenues (net of deposits into theHeritage Fund) accounted for an estimated 69percent of current spending. Finally, investmentincome received from the Heritage Fundaccounted for an additional six percent ofspending (Boothe 1995, Alberta budgetdocuments and authors’ estimation).

Arguments that have been put forward insupport of the Bird-in-the-Hand approachinclude inter-generational equity, precautionarysavings and maintaining competitiveness inmanufacturing and other non-resource sectors(avoidance of the so-called “Dutch disease”).29

The equity argument in this case differs from theone discussed earlier (i.e. skewing GR in favour ofpresent generations to compensate for lower non-resource GDP). In this case, equity reflects theperception that current spending of resourcerevenue is wasteful by definition, while saving isfar-sighted and disciplined. Precautionary saving,as above, responds to the possibility of negativeshocks, such as a sudden downturn in resourceprices or an adverse shock to the non-oileconomy. Similarly, the prospect of increasinggovernment obligations for health care spendingin an aging society would seem to recommendsaving more for the future.

The Dutch disease phenomenon consists oftwo effects, one operating through the currency

and the other through aggregate demand. Thefirst effect involves the appreciation of the localcurrency, due to the impact of export revenues.The higher exchange rate makes imported goodscheaper than those manufactured at home, thusundermining the competitiveness of the domesticmanufacturing sector. The second effect involvesthe potentially inflationary impact of highgovernment spending when it is financed byresource revenues rather than taxation. If inflationfeeds through to wage levels, competitiveness isagain undermined. The BIH approach limitsthese effects, provided the equity of the savingsfund is held in foreign assets, as is the case withNorway. This practice limits the pressure on thedomestic currency by limiting the annual inflowof revenue. In the same way, the inflationaryimpact of government spending is restrained.

We believe that most of these arguments eithergo too far in favouring future generations or donot apply fully to Alberta. Barnett and Ossowski(2002) describe the Bird-in-the-Hand approachas “an extreme form of precautionary savings, inthat it is tantamount to assuming that therewould be no future oil revenues” (p. 9). Such anoutcome would occur, for example, if there werea sudden, permanent collapse in the price of oil.But since the likelihood of such an outcome isextremely small, the BIH approach is excessivelycautious. Further, as we will show below, the BIHapproach in its pure form entails an extreme biasin the allocation of resource benefits in favour offuture generations.30

In terms of Dutch disease, we note that, as oneprovince in a large federation, Alberta’s influenceon the Canadian dollar is more limited than itwould be if, as Norway, it were a nationaleconomy with its own currency. Further, labourmobility within the federation helps moderatewage pressures, compared with what they wouldbe otherwise. Historically, there has been scantevidence of an adverse impact on non-resourcesectors in Alberta. Indeed, one could argue that adiversified economy did not substantially exist in

Commentary 263 | 11


29 See Saunders (2008), Scoffield (2006) and Bjerkholt and Niculescu (2004).

30 York (2008) provides a telling illustration of the future bias of BIH in the context of East Timor.

Alberta prior to the discovery of oil and gas, andit is the exploitation of these resources that hasstimulated the development of manufacturing inupstream and downstream industries. Morerecently, manpower shortages and wage pressureshave started to resemble the symptoms of Dutchdisease. Yet these results are clearly due to theinvestment boom in the oil sands rather than thegovernment’s fiscal policy.

Therefore, we conclude that the Bird-in-the-Hand approach does not provide a compellingframework for guiding fiscal policy. Nonetheless,some of the arguments above have validity interms of savings funds in general. To the extentthat the recent surge in the Canadian dollar maybe partially due to increased exports of oil andnatural gas, holding the equity of the fund“offshore” — i.e., in foreign assets — couldprovide some benefit by reducing upwardpressure on the dollar.31 Similarly, any savingsplan would by definition restrain governmentspending, thereby moderating potentialinflationary pressures.

In any case, using 2007 as a starting point, thePermanent Resource Income Model actually callsfor more saving than BIH in all but the mostoptimistic scenarios, if one follows the Norwegianapproach of saving only direct resourcerevenues.32 In other words, using realisticassumptions, Alberta should not follow Norway’sexample, but in fact it should save more.

To illustrate, we consider both pure andpractical applications of Bird-in-the-Hand underthe reference forecast (Figure 5). The pureapplication would save both direct and indirectresource revenues,33 while the practical(Norwegian style) application focuses only ondirect revenues. We apply a transfer rate of 3.5percent to the fund equity – this amount ofinvestment income is transferred each year to the

government’s budget for spending. This rate isequal to our reference forecast for the real returnon investment.

The extreme future bias of the pure BIHapproach is evident. As argued above, we do notfind such a bias to be ethically compelling.Moreover, the savings commitment for thisversion of BIH is extreme. As was shown inFigure 2, the sum of direct and estimated indirectrevenues is only slightly less than total resourcerevenue. During the three years 2007-2009, thissum amounts to approximately 77 percent of theforecast for total government spending providedin Budget 2007 and 2.5 times the value of directresource revenues. In political terms, this savingsplan would probably be impossible, even if itwere desirable.

In contrast, the practical version of BIH (savingonly direct revenues) projects a gradual downwardtrend in GR per capita. While this trend is not sopronounced as under the Fiscal Responsibility Actand therefore perhaps more acceptable (compareFigure 3), we note a tendency for fluctuations inthe first 25 years of the plan that cannot bejustified in terms of any meaningful economic orsocial objectives. This outcome results from thearbitrary decision to limit savings to a particularcategory of revenue rather than focusing on acompelling long-term goal, such as sustaining GR

per capita. For this reason, as argued above, wefavour the constant spending policy model(PRIM). As already discussed, this policy requiressavings in excess of direct resource revenues — 39percent more during the five years 2007 to 2011under the reference forecast. In return, it resultsin a long-run value of GR per capita that isapproximately 29 percent higher than thepractical (Norwegian) version of BIH ($4,501versus $3,502 after 2095).

| 12 Commentary 263

C.D. Howe Institute

31 See Laidler (2008) for a discussion of the link between the Canadian dollar and resource prices. According to AHST (2008), just over 30percent of the equity of the Heritage Fund was held in foreign-denominated investments, as of December 31, 2007.

32 See Appendix C for the sensitivity analysis.

33 It would not save diversified revenues, since these revenues are sustained after exhaustion of the resource. Unlike PRIM, which focuses onsmoothing the benefits from all sources, BIH only saves revenues from exhaustible sources.

Reforming the Budgeting Process

Budget Planning

Our discussion leads to the followingrecommendations for changes to Alberta’sbudgeting process.

• Target a constant per-capita level of spendingout of resource wealth.34

Our estimate of GR per capita in the referencecase is $4,501. The sensitivity analysis(Appendix C) shows how this value varies withassumptions about the forecast.

• Pursue an aggressive program of savings, basedon the model’s estimates.In our reference case, required saving in thenear-term (2007-2011) is equal to 139 percentof direct resource revenues. The sensitivityanalysis (Appendix C) shows how this

requirement varies with assumptions about theforecast. In the most plausible scenarios, thesavings requirement is uniformly greater thandirect revenues. In comparison, the current ruleunder the Fiscal Responsibility Act results in asavings rate (near-term) of less than 50 percentof direct resource revenues in the referencecase. Clearly, the government has significantwork to do in closing the gap between ourrecommended target and the existing policy.Achieving the target will require a combinationof reductions in annual spending and increasesin non-resource tax levels.

• Revise the plan regularly.As discussed, the estimate of a constant valueof GR per capita depends upon forecast valuesof future variables. As information changes,the forecast changes and, therefore, theestimated value of GR must change as well. Itfollows that the goal of a constant value of GR

Commentary 263 | 13


Figure 5: Resource-based Spending under PRIM and BIH

4,5014,501

8,639

600

3,502

4,587

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,00020

05

2010

2015

2020

2025

2030

2035

2040

2045

2050

2055

2060

2065

2070

2075

2080

2085

2090

2095

2100

PRIM BIH pure BIH practical


$C (

2007

) pe

r ca

pita

34 In technical terms, this is known as the Non-resource Primary Deficit. See Appendix B and Busby (2008) for a discussion.

will only be realized in the hypothetical sense,within the context of a given year’s plan. Inreality, the attained value of GR will vary fromyear to year as information — and thus theplan — changes as well.

Reporting and Data

Implementing this approach to budget planningcalls for the following changes in the way theAlberta government reports its results and in thedata available to budget planners and the generalpublic.

• Consolidate the government’s savings funds. A coherent approach to long-term fiscalplanning requires a comprehensive view of thegovernment’s budget. The current practice ofpresenting “the budget” in terms of a singleaccount (the General Revenue Fund) distinctfrom other funds and accounts (e.g., theHeritage Fund, the Sustainability Fund, theCapital Account, and the Alberta HeritageMedical Research and Endowment Fund)diverts attention from the big picture andmakes a long-term focus difficult. ThePermanent Resource Income Model assumesone comprehensive savings fund for financialassets and one current budget account.

• Publish estimates of indirect resource revenuesin addition to direct revenues in the publicaccounts and budget documents.Currently, the government’s financial reportingdistinguishes only direct resource revenuesfrom other forms of taxation. Thispresentation significantly underestimates thetrue level of revenues from natural resourcesand thus distorts the public’s perception of thesources of government wealth. An informedpublic debate about the allocation of resourcewealth over time requires full informationabout the amounts involved.

• Improve estimation techniques for indirectand diversified resource revenues.Unlike direct revenues, which can be easilyidentified through the accounting trail,estimating indirect revenues requires an

economic modelling exercise in order to isolatethe components of corporate and personalincome taxes (and other taxes) that come fromresource-based activities. Further researcheffort is needed to improve the availablemodelling capacity. This requirement is evenmore acute in relation to diversified revenues.Our current ability to estimate this categoryamounts to little more than educated guessingand yet, as demonstrated, these revenues play akey role in planning a coherent fiscal policy.

• Display long-term consequences. Budget debates typically focus on next year’stotal balance — i.e., whether the budget isforecast to be in surplus or deficit. In addition,the government produces a three-year planwith the budget. Yet, because non-renewablenatural resources will run out, theconsequences of spending resource revenuesare permanent. Therefore, budget plannersshould present the expected consequences ofcurrent spending decisions in the short,medium and long-term. For example, ouranalysis of the Fiscal Responsibility Act above(Figure 3) shows in a simple and clear way thathigh spending today will permanently lowerspending in the future, under the assumptionsof the forecast. This type of information isessential for an informed public debate.

Conclusion

In this Commentary, we have sought to answer (i)whether the government of Alberta has savedenough of its resource wealth to date, (ii) whatpolicy is sustainable, moving forward, (iii) whatare the implications of this policy for currentbudget planning, and (iv) whether the provinceshould follow Norway’s example of saving all ofits direct resource revenues. We concluded thatalthough the government has saved more thenenough to date, it now needs to embark on anaggressive savings program (139 percent of directresource revenues during the five years 2007-2011under the reference forecast) in order to sustain aconstant level of per capita spending out of

| 14 Commentary 263

C.D. Howe Institute

resource wealth. Indeed, in most scenarios, itmust save more than the Norwegian standard,not less.

This result may seem somewhat paradoxical.On the one hand, the savings rate has been morethan sufficient to date. On the other hand, thecurrent requirement under the Fiscal ResponsibilityAct — which even on its own will take resourcesavings to new highs — nonetheless falls seriouslyshort of what is needed to meet the sustainabilitybenchmark in the future.

The explanation for this apparent contradictionlies in the very large scale of borrowing and savingentailed in the Permanent Resource Income Model.Unlike the Norwegian approach, the PRIMmanages all three categories of resource revenuesover time — direct, indirect and diversified. Giventhe large sums involved, the model generates verylarge targets, both for borrowing, whenappropriate, and for saving. Our analysis of thehistorical question (starting in 1948) shows thatAlberta has only recently passed the prescribedtransition date from borrowing to saving (1999).The sudden swing from more than enough savingto grossly inadequate saving is consistent with the model.

We have followed a rather conventional,optimistic view of prospects for the oil and gassector — one that foresees only moderatedownside risks in terms of prices and revenues. Incontrast, the possibility exists for major negativeshocks. For example, the development ofalternative technologies or stringentenvironmental standards could render the

resource obsolete even before exhaustion.Alternatively, environmental degradation orresource scarcity may make future generationsworse off than present. All these possibilitiespoint to a heightened precautionary motive forsavings.35 Thus an argument can be made thatour savings target — as aggressive as it is —perhaps should be viewed as a minimumthreshold for current policy.

Planning for a sustainable fiscal policy iscomplicated by large uncertainties andapproximation errors related to future oil and gasprices, recoverable reserves, indirect revenues, anddiversification, among other things. Combinedwith the more garden-variety fluctuations in theeconomic environment, these factors suggest thatthe estimate of permanent income that underliesthe model will constantly change. While thisvolatility is less than ideal, it is certainly notunusual in public affairs. For example, Canadiansare accustomed to variability in the conduct ofmonetary policy, and we have developedsignificant institutional capacity and mechanismsto manage uncertainties in this context.Therefore, there is every reason to believe thatstakeholders would be able to adapt to variabilityin the conduct of a sustainable fiscal policy.Provided the government updates its estimate ofpermanent income in a timely and transparentmanner, the adoption of this approach shouldbring greater coherence and discipline to theformulation of fiscal policy than has beenexperienced to date.

Commentary 263 | 15


35 On the other hand, we note that the most efficient approach to environmental and scarcity problems is to control them at the outset, ratherthan letting them get out of hand and then seeking to compensate victims after the fact.

| 16 Commentary 263

C.D. Howe Institute

36 The government's fiscal year runs April 1 - March 31, whereas our analysis employs calendar years. For simplicity, we attribute data to the firstyear of the split fiscal year, e.g., 2006 in the case of fiscal 2006/07.

37 One could quibble whether royalty taxes are levied on the resource or the company, since royalty formulas typically take into account muchfirm-related detail, including revenues and costs. However, in theory, the royalty represents a payment to the owner for the sale of the resource.Therefore, we classify it as a direct charge on the resource.

38 Statistics Canada has versions of the model available for the years 2000-2003.

Appendix A: Data

A1. Historical data

Horizon

Our historical analysis begins in 1948, which marked the beginning of major oil exploitation in Albertaand continues until fiscal 2006/07 inclusive.36

Direct resource revenues

We define direct revenues as those which are levied on the resource rather than the company. Thiscategory includes royalty taxes and Crown land leases. For practical purposes, we take it as equivalent tothe Alberta Public Accounts line item labelled “resource revenues.”37 We have assembled this data fromBoothe (1995) for the period 1948 to 1980 and from Alberta budget documents from 1981 to 2007.Due to the quasi-consolidation techniques applied by Boothe (1991, 1995), the values from 1976 to1980 had to be increased to account for transfers to the Heritage Fund.

Indirect resource revenues

We define indirect resource revenues as all other tax revenues generated by the oil and gas sector in theprovince. This category includes: corporate income taxes paid by oil and gas firms as well as upstreamand downstream firms (businesses that either service the sector or process its outputs); personal incometaxes paid by employees of such firms; and other taxes and fees paid by households that derive theirincome from such firms. Indirect resource revenues are not distinguished by particular line items in thepublic accounts and, therefore, it is necessary to employ some method for estimating them fromavailable data. The challenge is to extract the portion of revenues in these line items (e.g. corporateincome tax, personal income tax) that can be attributed to oil and gas activities in the province.

An ideal approach would involve using a dynamic simulation model of the Alberta economy tocounterfactually identify indirect resource revenues. Unfortunately, to the best of our knowledge, such amodel does not exist. Mansell and Shlenker (2006) employ Statistics Canada’s Interprovincial Input-Output Model to estimate the total impact of oil and gas extraction on Alberta’s economy during theperiod 1971 to 2004, and we use their results as the basis for a simple multiplier showing therelationship between indirect resource revenues and activity in the oil and gas sector. The InterprovincialInput-Output Model is static in nature, which means that it is calibrated for a particular year — 2001in the version used by Mansell and Shlenker.38 Given the length of our time frame — 149 years from1948 to 2095 — we opted against using the model directly.

We define the indirect revenue multiplier (IRM) as the ratio of the total value of indirect resourcerevenues in an average year to the total value of production of oil and gas (sales revenue) in the year.

Commentary 263 | 17


During the same period, the cumulative value of direct resource revenue was approximately $126billion. The $151 billion difference is the cumulative value of indirect resource revenues during thisperiod.

CAPP (2007a) provides data on aggregate sales revenue per year for oil and gas in Alberta. Thecumulative value of sales revenue for 1971-2004 was $710 billion. Thus, the baseline estimate of ourmultiplier is 0.213 (equal to 151/710). We then apply this multiplier to the sales revenue in every yearto obtain an expected value of indirect resource revenue that year.

We are aware that this calculation may be subject to distortion, arising from (i) changes in the taxcode over time and (ii) changes in the relative importance of conventional oil, natural gas and oil sandsin the product mix. For this and other reasons, we conduct sensitivity analysis in Appendix toinvestigate the effects of changes in the value of the multiplier. In addition to the baseline estimate ofIRM of 0.213, which we label medium, we also test high and low values of 0.25 and 0.15 respectively.These values are summarized in Table 1.

Alberta Finance (2007) claims that the use of theinput-output model overestimates the relative size ofthe oil and gas sector in provincial GDP. Weconclude, therefore, that the weight of uncertaintyon the IRM is likely on the low side.

Non-resource primary deficit

This measure is defined as the difference betweennon-resource primary revenues (i.e. non-resource

total revenues minus investment income) and current program expenditures. The necessary data onrevenue and expenditure are obtained from the same sources as direct resource revenues.

Net financial wealth

This measure is defined as the difference between the total of all the government’s financial assets,including the equity in savings funds, and its financial liabilities. At present, our series is only partial:we have an initial data point for 1948, obtained from the Public Accounts (Alberta 1948) and asubsequent series, 1981 to 2007, obtained from Alberta budget documents.

Rate of return

We have calculated annual rates of return for the Heritage Fund using data on income and equityobtained from AHSTF (2007) and AHSTF (2008). We consider these rates indicative of theopportunities available to Alberta government planners during the period of operation of the fund(1977 to 2007). We use these rates as the basis for calculating present values during this period.

For the earlier period (1948 to 1976), we consider returns on a hypothetical portfolio consisting of amix of bonds and equities. For 1948 to 1956, we assume an equal mix of government and industrialbonds. For 1957 to 1976, we assume one-third government bonds, one-third industrial bonds and one-third equities. For government bonds, we use average yields on 10-year maturities. For industrial bonds,we use annual average yields reported by McLeod, Young and Weir. For equities, we use the benchmarkindex of the Toronto Stock Exchange. The data are obtained from Statistics Canada, Historical Statisticsof Canada, Cat. No.11-516-XIE, sections J471-480 (bond yields) and J481-494 (TSE index).

Table 1: Multipliers

IRM DR

high 0.250 0.250

medium 0.213 0.150

low 0.150 0.000

IRM: indirect revenue multiplier

DR: diversification rate

| 18 Commentary 263

C.D. Howe Institute

Table 2 summarizes the rate of return data. Amaximum nominal value of 15.7 percent is obtainedin 1980, with a minimum value of -8.4 percent in1948. The decadal averages are indicated as well.

Inflation

Our measure of the inflation rate for 1948 to 1978is the national consumer “all-items” price index,obtained from Statistics Canada, CANSIM seriesv41693271. For 1979 to 2007, we use the provincialconsumer “all-items” price index, CANSIM seriesv41694625. While the implicit GDP price deflatorwould seem to be a more comprehensive measure of

inflation, we could not find consistent data on this statistic prior to 1961.

Population

We have obtained annual population data from Statistics Canada, CANSIM series V15.

A.2. Forecast data

Horizon

Our forecast period begins in 2007 and terminates with the anticipated exhaustion of the resource stockin 2095 (see below for details).

Resource prices

EIA (2008) and IEA (2007) long-term price forecasts of oil are averaged into one price path for ourreference case. The EIA forecasts of oil prices are based on a weighted average price of imported low-sulphur oil delivered to US refiners, whereas the IEA forecasts are based on the price of crude oilimports. Natural gas prices are taken from EIA (2008) and are based on average wellhead prices for theUS (lower 48 states). Prices are converted into $C at a fixed rate of 0.90 US/C. According to thisforecast, the price of conventional oil falls from $91.65 per barrel in 2008 to $65.35 in 2016 and thenrises gradually to $75.55 in 2030, where it remains subsequently (all figures $C 2007).

For oil sands, most of Alberta’s royalty taxes after 2007 will be based on the price of bitumen, alower-grade commodity than the benchmark light, sweet grades. For the years 2006 to 2010, Alberta(2007) uses an average price conversion factor between bitumen and the light, sweet benchmark (WTI)of approximately 0.45. Applying this factor to the price for conventional oil yields our forecast of theprice of bitumen. The trend of the bitumen price follows that of conventional oil, adjusted by theconversion factor.

The forecast of the natural gas price envisages a fall from $7.02 per thousand cubic feet in 2008 to$5.91 in 2016. It then rises gradually to $7.37 in 2030 ($C 2007). The EIA attributes the softening inprice during the first decade to increased supply of liquefied natural gas and demand destruction due tothe relatively high near-term prices.

Table 2: Rates of Return (nominal %)

max value: 1980 15.7

min value: 1948 -8.4

averages: 1948-07 7.6

1948-59 2.5

1960-69 7.4

1970-79 9.0

1980-89 12.1

1990-99 8.7

2000-07 6.5

2008+ 5.6

Source: Authors’ calculations; Statistics Canada, HistoricalStatistics of Canada; AHSTF (2007, 2008).

Commentary 263 | 19


39 Authors’ calculation for the period 2000-2006, based on data from CAPP (2007a).

Sensitivity analysis on resource prices is based on the deviation between the reference and low-priceforecasts from EIA (2007). The gradual separation of the forecasts, starting from a common value in2007, results in a 40 percent deviation between the two in 2030. We apply the same deviation patternto our reference price data (discussed above) to obtain both our low- and high (inverse deviationpattern) price forecasts.

Reserves

Our forecast assumes recoverable reserves in the oil sands of 78 billion barrels as of 2007, which is anaverage of the values reported in BP (2007) and World Oil Journal (2006). Based on data from CAPP(2007a), we estimate remaining reserves of conventional oil and natural gas of 1.623 billion barrels and40,300 billion cubic feet respectively. Due to uncertainty, estimates of reserves from coal-bed methanehave not been included in our forecast.

Recent experience indicates an average replacement rate of reserves of conventional oil and naturalgas from new drilling equal to 60 percent of annual production.39 But these rates are likely to diminish(Scott 2007). To accommodate this possibility, our forecast begins with a 60 percent replacement rate in2007 for both conventional oil and natural gas, with conventional oil falling to zero in 2013 and withnatural gas falling to 30 percent in 2018 and zero thereafter.

Production

For the oil sands, our forecast follows CAPP (2007b) initially, rising to 1,387 million barrels per year(3.8 million per day) in 2020. We conjecture that the trend continues rising, reaching 1,643 millionbarrels per year (4.5 million per day) in 2027, where it remains until starting to fall in 2032. Weassume a decline rate of three percent per annum for the remainder of the period, which is similar toassumptions made in Segura (2006) and Davoodi (2002) regarding conventional oil. This productionprofile leads to exhaustion of reserves in 2095.

For conventional oil, we assume a constant rate of decline of production of 9 percent per year, basedon data from Alberta (2007) and CAPP (2007a). This value is slightly higher than the actual declinerate over the last 10 years in CAPP (2007a), signifying an ongoing decrease in production as reservesdwindle. The forecast starts at 183 million barrels per year in 2007 and falls thereafter, taking intoaccount the decline rate and the partial replacement of reserves discussed above. Production falls to zerowith the exhaustion of reserves in 2026. The same decline rate is used for natural gas. Therefore,following a similar approach, we forecast gas production falling from 5.2 trillion cubic feet in 2007 toexhaustion in 2026.

Sector revenues

The preceding forecasts of prices and production allow us to predict the total sales value of oil and gasproduction in Alberta during the next century, which we then use as the basis for our forecast of directand indirect resource revenues for the government.

| 20 Commentary 263

C.D. Howe Institute

Direct resource revenues

We base our prediction of direct resource revenues (royalties, leases, rentals and fees) on the sectorrevenues, using historical absorption rates. In reality, there is an endogenous relationship betweenroyalty rates and sector revenues, as firms’ production decisions depend in part on royalty rates.However, a rigorous modelling of these feedbacks is beyond the scope of the paper. Instead we employsensitivity analysis in Appendix C to test different scenarios.

Royalty rates are set at historical levels for the first two years of our forecast period and then shiftupwards in 2009 with the implementation of the new royalty regime announced this year following thereport of the Alberta Royalty Review Panel. These shifts were stress tested against the forecasts outlinedon p.17 in ARRP (2007).

For natural gas, we assume royalty taxes initially accrue at a rate of 14 percent of production value,shift to 16 percent in 2009, fall to 15 percent in 2012 and finally to 14 percent in 2016, remaining atthis level until exhaustion. For conventional oil, we assume royalty taxes initially accrue at 6 percent ofproduction value, shift to 10 percent in 2009, fall to 9 percent in 2016, and then remain at this levelthereafter. For oil sands, we assume royalty taxes initially accrue at a rate of 6 percent of productionvalue, shift to 8 percent in 2009, rise to 9 percent in 2026, then gradually drop to 8 percent in 2042, 7percent in 2055 and 6 percent in 2069 where it remains for the last years before exhaustion in 2095.Reductions in absorption rates over time are due to “low productivity offsets” as the quality ofremaining reserves declines.

Based on Alberta budget documents, we note that lease sales amounted on average to 15 percent ofroyalty taxes from oil and gas during the period 2004-2007. We assume this rate to continue in ourforecast. Finally, rentals and fees yielded the government $150 million annually during the period 2000-2006, an amount we assume will continue in our forecast.

Indirect resource revenues

We estimate indirect resource revenues by the application of two multipliers to the forecast sales values. The first is the indirect revenue multiplier (IRM) defined in the historical data. The second,which we call the diversification rate (DR), is intended to capture the shift, in upstream anddownstream industries, from servicing and processing domestic oil and gas, to exporting goods andservices out-of-province or servicing other unrelated domestic sectors. If these upstream anddownstream firms do not achieve any diversification – if they remain completely dependent on thedomestic oil and gas industry – then they will dwindle and die as the resource base diminishes and isexhausted. In that event, the government’s indirect resource revenues will also diminish to zero alongwith the resource base. In contrast, if upstream and downstream firms succeed at diversifying fromdomestic oil and gas, then the government’s revenues from these industries will be sustained.

Our view of economic development is that the pressure for diversification becomes particularly acutewhen the original base for upstream and downstream firms starts to diminish. In this vein, we note thatthe maximum value of indirect revenues in our reference forecast – and thus the maximum value of oiland gas production — occurred in 2005. Therefore, we use 2005 as the benchmark for defining valuesof the diversification rate in subsequent years. For example, if indirect resource revenues in 2010 are $5billion lower than in 2005 and DR = 0.15, then 15 percent of this loss, or $750 million, will berecouped by diversification from domestic oil and gas. In this case, the net loss to the government’s

Commentary 263 | 21


coffers will be $4.25 billion.40 By assumption, the value of DR prior to 2005 is always zero. In this way,the diversification rate directly addresses the question of how much of indirect revenues can bemaintained as oil and gas resources diminish.

Unfortunately, we are not aware of any empirical research that can be used to ground our value ofDR. Therefore, we use plausible conjectures. We believe it is prudent to err on the low side with thisvalue. First of all, diversification can only occur in upstream or downstream industries, not the primaryoil and gas sector itself. While we do not know the relative contributions of the sectors to indirectrevenues, we suggest that 50 percent is a reasonable hypothesis on the upper bound of the contributionof the upstream and downstream sectors, leaving the remaining 50 percent for the oil and gas industryitself. Thus complete diversification is represented by a value of DR = 0.5.

Second, we believe that complete diversification is unlikely to occur as domestic oil and gasproduction diminishes. Complete diversification would imply immediate replacement of lost businesswith either export sales or new domestic customers. In contrast, anecdotal evidence suggests thatdiversification is a much slower process, usually following upon a period of crisis and contraction.

Furthermore, some upstream and downstream industries simply may not be diversifiable. In this vein,ARRP (2007, 33) observes that the petrochemical industry “once had access to inexpensive natural gasas feedstock, but as pipeline capacity expanded, the gas was available for export and its price became setby market forces. Low natural gas prices had been this industry’s main advantage, but that advantagehas disappeared in recent years as North American natural gas prices have strengthened.” Mansell andShlenker (2006, 22) note that the petrochemical industry accounted for “over 20 percent ofmanufacturing value added in Alberta” in 2003 and further that “it would be hard to argue that thepetrochemical industry would exist in Alberta in the absence of the oil and gas industry.”

Finally, companies that are diversifying from the Alberta resource market are also likely to relocatesome portion of activity to their new markets, with the result that some portion of tax revenues wouldbe lost to other jurisdictions. For example, head office jobs may remain in Alberta while field activities,manufacturing or processing may relocate.

Ultimately, it seems implausible that an economy would experience the decline of a major extractiveindustry without experiencing some degree of contraction. Accordingly, we suggest 0.25 as a maximumplausible value for DR, and we test lower values of 0.15 and 0 as well, the latter representing theextreme (and also implausible) case of no diversification at all. In the text, we refer to these values ashigh, medium and low respectively. They are summarized in Table 2.

Inflation

The inflation rate is forecast to be constant at 2.0 percent, which is the central value of the Bank ofCanada’s present target range.

Rate of return

The real return on investment is forecast to be constant at a rate of 3.5 percent per annum, comparedwith an average actual rate of 3.4 percent over the period 1948-2007 and 4.8 percent over the morerecent period 1990-2007. This real rate is equivalent to a nominal value of 5.57 per cent per annum,given the expected inflation rate. Sensitivity analysis is performed in Appendix C at low and high ratesof 3.0 and 4.0 percent respectively.

40 We apply DR to differences in the real value of indirect revenues from the 2005 benchmark, rather than nominal differences.

| 22 Commentary 263

C.D. Howe Institute

Population projections

Following C.D. Howe Institute projections, Alberta’s population is forecast to grow at a rate of 1.77percent in 2008, compared with an average actual growth rate of 1.93 percent during the period 2000-2007. The growth rate is forecast to fall gradually in subsequent periods, reaching zero in 2058, yieldinga steady-state population of 4.54 million. For sensitivity analysis in Appendix C, a high populationscenario forecasts population growth to continue until 2069, yielding a steady-state value of 4.66million. Meanwhile, a low-population scenario forecasts growth continuing until 2038, for a steady-state value of 3.91 million.

Commentary 263 | 23


Most theoretical treatments of the permanent income model deal with constant rates of interest,inflation and population growth. In contrast, given the large historical component of our data set, wehave variable rates for over approximately 40 percent of the planning horizon.

A particular challenge concerns how to handle negative real interest rates, which occurred 13 times inour 59-year historical sample (1948-2006). Negative real interest rates have the effect of inflatingpresent values, and they raise important conceptual issues regarding our assumption of completeknowledge or foresight. In particular, is it reasonable to assume that a planner with complete knowledgewould hold financial assets during a period of negative real interest rates? Upon reflection, it seems clearthat such a planner would switch into commodities during such periods — for example, oil — sincetheir values would be growing faster than financial assets. Therefore, we set the planner’s discount rateduring the historical period as the maximum of the real interest rate and 0 (equivalently the maximumof the nominal interest rate and the inflation rate).

Further, we note that the duality between constant expenditure and constant wealth is broken whenrates of return vary over a subset of the planning period.41 Therefore, with variable returns, themodeller must choose between holding constant either expenditure or wealth. We choose the former,since we view wealth as the means to an end — expenditure — and not an end in itself. In thisapproach, fluctuations in wealth can act as a shock absorber to help smooth expenditure during periodsof volatility in returns. When we move into our forecast period (2007-2095), rates of return areassumed constant (expected value) and the link between constant expenditure and constant wealth isrestored. Thus, in the long run, the interpretation of permanent income as the return on total wealth isvalid.

Davoodi (2002) provides a useful presentation of the model with variable rates. However, hisformulas are based on smoothing wealth rather than expenditure. In contrast, we present a version ofthe model for smoothing expenditure. Let it, rt, πt and nt represent the nominal interest rate, realinterest rate, inflation rate and population growth rate respectively, in period t. Let T denote the lastperiod of extraction (2095 in our forecast); i.e., the resource is exhausted in all periods t>T. During thehistorical period (1948-2006), it, rt, πt and nt are variable, while during the forecast period (they areconstant and satisfy the relationship (1 + i) > (1 + n) (1 + π) (B1)or equivalently r > n.42 Assumption (B1) requires that the nominal rate of return is large enough tocover more than the increase in population and the price level — a necessary condition for maintaininga constant real per capita level of expenditure out of savings in steady state (i.e. after T).

Let Rt denote the government’s resource revenues at t, GRt its expenditure out of resource wealth and

At its stock of financial assets. It is important to note that GRt is not the only source of spending, as the

government also has non-resource tax revenues, which we denote NRt. However, if our concepts are tobe meaningful, then the government can only have one source of borrowing — borrowing to financeGR

t when it exceeds Rt — and one source of saving — the surplus of Rt when it exceeds GRt . These

values would not equal net borrowing or net saving if the government offset them in some otheraccount — for example, if the government ran a surplus in a resource account while running a deficit ina general budget account. For this reason, the budgeting process must take a unified view of allgovernment accounts and funds. It follows that, since all saving is resource saving, all financial assets ordebts are resource-based as well.

Appendix B: Mechanics of the Permanent Resource Income Model

41 This result is proven formally in Shiell and Busby (2008).

42 The absence of a time subscript indicates a constant value.

| 24 Commentary 263

C.D. Howe Institute

Due to the integration of accounts, the sustainability rule imposes discipline on all components ofthe budget. In particular, discipline takes the form of a requirement that total government expenditureis covered by the sum of GR

t and NRt; there is no other source of borrowing or revenue on a separate iscovered by the sum of GR

t and NRt; there is no other source of borrowing or revenue on a separateaccount. Denoting total government expenditure as Gt, we have Gt = GR

t + NRt .Rearranging yields Gt - NRt = GR

t , (B2)where the left side is referred to as the non-resource primary deficit (NRPD). This measures theamount by which non-resource tax revenues fall short of covering total government expenditure, andthe shortfall is made up by GR

t. The literature on fiscal sustainability identifies the NRPD as the target of policy. Permanent income

determines GRt , which in turn is equal to the allowable annual NRPD. Since GR

t is constant (in percapita terms in our version), NRPD must also be constant (in per capita terms). The government canmeet this target by adjusting total expenditure or non-resource taxation levels. Thus, the setting of Gt,NRt and GR

t are integrated in the budgeting process, consistent with a sustainability rule based on equalsharing of resource wealth.

The government’s budget constraint is At+1 = (At + Rt + NRt - Gt)(1 + it + 1) which uponsubstituting from (B2) becomes At + 1 = (At + Rt - G

Rt)(1 + it + 1) (B3)

This equation can be rewritten to show the contribution of the budget’s primary and total balances. Inparticular, At + 1 - At = (Rt - G

Rt) + it + 1(At + Rt - G

Rt) (B3')

The first term on the right of is the primary balance, the second term is net investment income, andthe sum is the total balance. The primary balance provides a measure of saving out of resource revenues,while the total balance provides a measure of net saving, taking account of net investment income(income on financial assets less interest payments on debt). It is the latter measure, total balance, thatprovides the change in the government’s financial position for the year and the most common measureof the government’s surplus or deficit.

To demonstrate our solution of the model, it will be useful to consider (B3) in real, per capita terms.For this purpose, let Nt and Pt denote population and price level at t, respectively. By definition Nt + 1 = Nt(1 + nt + 1) and Pt + 1 = Pt(1 + πt + 1). Further the Fisher identity definesthe relationship between real and nominal interest rates, i.e.

Then dividing through both sides of (B3) by Nt + 1 and Pt + 1 yields

(B4)

where lower case letters denote real, per capita values (ρ denotes real resource revenues per capita, toavoid confusion with the real interest rate, r). Note that

reflects the real rate of interest, net of adjustment for population growth.Equation (B4) defines a first-order difference equation that can be solved iteratively to obtain the

government’s present value budget constraint (in real, per capita terms), i.e.,

t

tt

irπ+

+=+111

( ) ⎟⎟⎠

⎞⎜⎜⎝

⎛++−+=

+

++

1

11 1

1aat

tRtttt n

rgρ

) ⎟⎟⎠

⎞⎜⎜⎝

⎛++

+

+

1

1

11

t

t

nr

Commentary 263 | 25


The left-hand side is equal to the present value of resource-based expenditure plus the present value offinancial wealth at T+1 (the period after exhaustion of the resource base). The right-hand side is equalto the government’s total wealth at time 0, i.e. initial financial assets a0 plus the present value of thestream of resource revenues.Let g* represent the maximum level of real, per capita expenditure out of resource wealth which can besustained indefinitely. By assumption rt = r and nt = n for t ≥T. Thus, from (B4) we have

Furthermore, sustainability requires after exhaustion that aT + 2 = aT + 1. Substituting into the expressionabove yields

which upon solving yields

Note that this expression reflects the standard annuity formula, adjusted for per capita terms. Nowsubstituting for g

R

k and aT+1 in (B5), we obtain our solution for g*:

Interpretation of this expression is easier in the special case when rt=r and nt=n in all periods. In that case,

The expression in square brackets is the government’s total wealth at time 0, while the precedingexpression in parentheses is the standard annuity formula (adjusted for population growth). Thus wehave g* equal to permanent income.

In fact, our calculation of g* is altered by the continued flow of diversified revenues after theexhaustion date. As explained in Appendix A, these are revenues of upstream and downstreamindustries which have managed to diversify away from dependence on the domestic oil and gas sector.Until T, we include these revenues in the measure of total resource revenues, ρt. However, after T, wemust account for them separately. We denote these post-exhaustion revenues as v, and we conjecture

( ) ⎟⎠⎞⎜

⎝⎛

++−= ++ n

rgTT 11aa *

12

( ) ⎟⎠⎞⎜

⎝⎛

++−= ++ n

rgTT 11aa *

11

⎟⎠⎞⎜

⎝⎛

−+=+ nr

rgT1a *

1

( )

( ) ( )∏∑∏

∑ ∏+

= ++

== +

+

== +

+

−+++

++

=

1

1 11

11 1

1

11 1

100

*

)/()1(11

a

T

j nr

T

kk

j nr

T

kk

j nr

k

j

j

j

j

j

j

nrrg

ρρ

( ) ⎥⎦⎤

⎢⎣⎡ +⎟

⎠⎞⎜

⎝⎛

+−= ∑

=++

T

k

krn

krnrg

011

0* a

1ρ

( ) ( ) ( )∑ ∏∏∑ ∏ == +

++

= ++

+

== +

+++=++

T

kk

j nr

kT

j nr

TT

kk

j nr

RkR

j

j

j

j

j

j

gg1

1 11001

1 111

11 1

10 aa ρρ

(B6)

(B6')

(B5)

(B6'')

(B7)

| 26 Commentary 263

C.D. Howe Institute

industries which have managed to diversify away from dependence on the domestic oil and gas sector.Until T, we include these revenues in the measure of total resource revenues, ρt. However, after T, wemust account for them separately. We denote these post-exhaustion revenues as v, and we conjecture thelevel to be constant in per capita terms. (In any event, our forecast of population growth is zero after2058.) In practice, the adjustment is easily made. We replace g* in equations (B6), (B6') and (B6'') withg*-v and then proceed as above. The solution for g* is now

the only difference being the addition of the term

to the numerator. This term is simply the present value of the indefinite stream of v, starting at T anddiscounted back to 0. Thus the government’s total resource wealth (the numerator) is increased by thisamount.

The exercises we perform are purely partial in nature, in that they do not take into account thefeedback that alternative savings policies would have on the economy. It is not clear to us that thisrepresents a major omission. The main effect of alternative policies would be to impose greater restrainton government spending in some periods and less restraint in others. Since the Alberta economy islargely export driven, it is not clear that the real growth rate would be much affected by these changes.

( ) ( )

( ) ( )∏∑ ∏

∑ ∏∏+

= ++

== +

+

=+

= ++

= ++

−+++

−++++

=

1

1 11

11 1

1

11

1 11

1 1100

*

)/()1(11

)/()1(va

T

j nr

T

kk

j nr

T

kT

j nrk

j nr

k

j

j

j

j

j

j

j

j

nrr

nrr

g

ρρ

( )∏ +

= ++

−+1

1 11

)/()1(v T

j nr

j

j

nrr

Commentary 263 | 27


Our estimate of the fiscal plan under the Permanent Resource Income Model (PRIM) depends uponthe forecasted values of uncertain variables, including resource prices, reserve size, annual productionrates, royalty rates, the indirect revenue multiplier (IRM), the diversification rate (DR), the real interestrate and annual population growth. Appendix A presents reference forecasts for these variables, as wellas high and low forecasts for selected variables to be subjected to sensitivity analysis. We have presentedthe results based upon the reference forecast in the main body of the text. Here we consider the impactsof adopting the higher or lower forecasts.

Certain regularities emerge. For example, resource prices, reserve size, production rates and royaltyrates affect the fiscal plan symmetrically through their role in determining the government’s resourcerevenues. Therefore, it is not necessary to subject them to sensitivity analysis separately. For ourpurposes, we focus on resource prices within this group. In addition, we test the impact of IRM, DR,the real interest rate and population growth.

Table C1 shows the impacts of high and low forecasts of the variables individually (partial sensitivityanalysis) as well as two combined scenarios. The impacts are summarized both in terms of the constantvalue of GR per capita that the model generates and in the near-term savings required. Savings areexpressed as a percent of direct resource revenues during the five-year period 2007-2011. The “highestGR case” corresponds with high resource prices, high IRM, high DR, high rate of return and lowpopulation growth. The “lowest GR case” is defined symmetrically.

High prices, high IRM and high DR all contribute to high wealth through the present value ofresource revenues. The rate of return has two opposite influences. First, a higher rate of return translatesinto lower present values ceteris paribus and thus lower wealth at any given time. Second, a higher rateof return increases the expenditure possibilities from any given level of wealth. From our experiments,we see that the second effect dominates, as a higher rate of return generates a higher value of GR percapita in the model. Finally, population growth affects GR per capita in an inverse fashion, as expected.

Appendix C: Sensitivity Analysis

Table C1: Permanent Resource Income Model

GR per capita($C 2007)

Required savings 2007-11(% of direct resource revenue)

reference case 4,501 139partial sensitivity analysisresource prices — high 5,439 111resource prices — low 3,564 171IRM — high 4,872 150IRM — low 3,870 119DR — high 4,713 134DR — low 4,185 145real interest rate — high 5,015 124real interest rate — low 3,832 158pop — high 4,449 141pop — low 4,933 123highest GR case 6,884 87lowest GR case 2,339 158

| 28 Commentary 263

C.D. Howe Institute

Table C1 indicates that, while numerical values vary, the qualitative features of our results are quiterobust. In particular, the required near-term savings under PRIM (2007-2011) exceeds direct resourcerevenues in all cases except the highest GR case. This exception is not surprising, since it correspondswith a case in which government wealth is extremely high and much of it accrues in the future. Itfollows that some of the burden of saving is shifted forward in this case. Yet, even this scenario impliesan aggressive near-term savings program by historical standards (87 percent of direct resource revenues).In contrast, we noted earlier that in the reference case the Fiscal Responsibility Act entails a near-termsavings rate of only 47 percent of direct revenues. Thus, we conclude that the requirement of anaggressive savings program under PRIM is robust to changes in the underlying variables.

Alberta. 2007. Alberta Budget 2007. Ministry of Finance.

Alberta. 1948. Public Accounts 1947-1948. TreasuryDepartment.

Alberta Finance. 2007. Economic Spotlight. “Energy and theAlberta Economy.”www.finance.alberta.ca/aboutalberta/spotlights/2007_0918_energy_ and_ab_economy.pdf. (Accessed March24, 2008)

AHSTF. 2007. Alberta Heritage Savings Trust Fund,Annual Report 2006-2007. www.finance.gov.ab.ca.(Accessed September 7, 2007).

AHSTF. 2008. Alberta Heritage Savings Trust Fund, ThirdQuarter Update 2007-2008. www.finance.gov.ab.ca.(Accessed September 7, 2007).

ARRP. 2007. Our Fair Share. Report of the Alberta RoyaltyReview Panel, September 18, 2007.www.albertaroyaltyreview.ca. (Accessed February 8,2008).

Barnett, Steven, and Rolando Ossowski. 2002.“Operational Aspects of Fiscal Policy in Oil-ProducingCountries.” IMF Working Paper 00/118. Washington:International Monetary Fund. www.imf.org. (AccessedJuly 7, 2007).

Bjerkholt, Olav, and Irene Niculescu. 2004. “Fiscal Rulesfor Economies with Nonrenewable Resources: Norwayand Venezuela.” In George Kopits, ed. Rules-BasedFiscal Policy in Emerging Markets. InternationalMonetary Fund. pp. 164-179.

Blanchard, Olivier Jean, and Stanley Fischer. 1989. Lectureson Macroeconomics. Cambridge, Mass. MIT Press.

Boothe, Paul. 1995. The Growth of Government Spending inAlberta. Canadian Tax Foundation.

Boothe, Paul. 1991. “Time Consistent Data for Alberta’sPublic Finances, 1968 to 1989.” Canadian Tax Journal.39(3), pp. 567-89.

BP. 2007. Statistical Review of World Energy 2007.www.bp.co.(Accessed August 30th, 2007).

Busby, Colin. 2008. "After the Oil Rush: A Blueprint forAlberta's Long-term Happiness." C.D. Howe Institutee-brief. Toronto: C.D. Howe Institute. February.

Canadian Association of Petroleum Producers. 2007.Statistical Handbook, www.capp.com. (Accessed July 1,2007).

CAPP. 2007. Canadian Oil and Gas Industry Outlook 2007.www.capp.ca. (Accessed: August 3, 2007).

Chen, Duanjie, Jack Mintz and Andrey Tarasov. 2007.“Federal and Provincial Tax Reforms: Let’s Get Back onTrack.” Toronto: C.D. Howe Institute. BackgrounderNo. 102.

Davoodi, Hamid R. 2002. “Assessing Fiscal Vulnerability,Fiscal Sustainability and Fiscal Stance in a NaturalResource Rich Country.” In Republic of Kazakhstan:Selected Issues and Statistical Appendix. IMF CountryReport No. 02/64.

Energy Information Administration. 2007. “Annual EnergyOutlook 2007 with Projections to 2030.” USDepartment of Energy. February. www.eia.doe.gov.(Accessed August 1, 2007).

EIA. 2008. “Annual Energy Outlook 2008: Revised EarlyRelease.” US Department of Energy.www.eia.doe.gov/oiaf/aeo/index.html. (Accessed March16, 2008).

Engel, Eduardo, and Rodrigo Valdes. 2000. “Optimal FiscalStrategy for Oil Exporting Countries.” IMF WorkingPaper 00/118. Washington: International MonetaryFund.

Fiscal Responsibility Act. 2007. Queen’s Printer. AlbertaGovernment.

www.qp.gov.ab.ca/Documents/acts/F15.CFM. (AccessedMarch 17, 2008).

Friedman, Milton. 1957. A Theory of the ConsumptionFunction. Princeton University Press.

IEA. 2007. “World Energy Outlook 2007: China and IndiaInsights.”

Kneebone, Ronald. 2006. “From Famine to Feast: TheEvolution of Budgeting Rules in Alberta.” CanadianTax Journal. 54(3), pp.657-73.

Laidler, David. 2008. “Fixing the Exchange Rate: Still aBad Idea.” Toronto: C.D. Howe Institute e-brief.www.cdhowe.org. (Accessed March 24, 2008).

Liuksila, Claire, Alejandro Garcia and Sheila Bassett. 1994.“Fiscal Policy in Oil-Producing Countries.” IMFWorking Paper 94/137.

Mansell, Robert, and Ron Shlenker. 2006. “Energy and theAlberta Economy: Past and Future Impacts andImplications.” Working Paper No. 1. Alberta EnergyFutures Project: University of Calgary. Institute forSustainable Energy, Environment, and Economy.www.iseee.ca. (Accessed August 17, 2007).

Popp, David. 2004. “ENTICE: Endogenous TechnologicalChange in the DICE Model of Global Warming.”Journal of Environmental Economics and Management.48, pp.742-768.

Saunders, Doug. 2008. “Frugal Norway Saves for Life Afterthe Boom.” The Globe and Mail. January 31.

Scott, Norval. 2007. “Oil Firms Find Reserves Elusive.”The Globe and Mail. July 25.

Commentary 263 | 29


References

Scoffield, Heather. 2006. “Too Much, Too Fast: CanAlberta Learn from Norway?” The Globe and Mail.October 21.

Segura, Alonso. 2006. “Management of Oil Wealth Underthe Permanent Income Hypothesis: The Case of SaoTome and Principe.” IMF Working Paper 06/183.

Shiell, Leslie, and Colin Busby. 2008. “Resource Revenuesand Fiscal Sustainability in Alberta.” University ofOttawa. Department of Economics. Working Paper.www.socialsciences.uottawa.ca/eco/eng/papers.asp

Tersman, Gunnar. 1991. “Oil, National Wealth, andCurrent and Future Consumption Possibilities.” IMFWorking Paper 91/60.

World Oil Journal. 2006. Houston. Gulf Publishing Co.September.

York, Geoffrey. 2008. “Oil Riches Amid the Squalor.” TheGlobe and Mail. February 17.

| 30 Commentary 263

C.D. Howe Institute

C.D. Howe Institute Commentary© is a periodic analysis of, and commentary on, current public policy issues. Michael Benedict and JamesFleming edited the manuscript; Diane King prepared it for publication. As with all Institute publications, the views expressed here arethose of the author and do not necessarily reflect the opinions of the Institute’s members or Board of Directors. Quotation withappropriate credit is permissible.

To order this publication please contact: Renouf Publishing Company Limited, 5369 Canotek Road, Ottawa, Ontario K1J 9J3; or theC.D. Howe Institute, 67 Yonge St., Suite 300, Toronto, Ontario M5E 1J8. The full text of this publication is also available on theInstitute’s website at www.cdhowe.org.

| 33 Commentary 263

RECENT C.D. HOWE INSTITUTE PUBLICATIONS

SUPPORT THE INSTITUTE

For more information on supporting the C.D. Howe Institute’s vital policy work, through charitable giving or membership,please go to www.cdhowe.org or call 416-865-1904. Learn more about the Institute's activities and how to make a donationat the same time. You will receive a tax receipt for your gift.

A REPUTATION FOR INDEPENDENT, NONPARTISAN RESEARCH

The C.D. Howe Institute’s reputation for independent, reasoned and relevant public policy research of the highest quality isits chief asset, and underpins the credibility and effectiveness of its work. Independence and nonpartisanship are coreInstitute values that inform its approach to research, guide the actions of its professional staff and limit the types of financialcontributions that the Institute will accept.

For our full Independence and Nonpartisanship Policy go to www.cdhowe.org.

May 2008 Schirle, Tammy. Greener Pastures: Understanding the Impact of Retirement Incentives in Defined-benefit PensionPlans. C.D. Howe Commentary 262.

May 2008 Wyman, Michael. Power Failure: Addressing the Causes of Underinvestment, Inefficiency and Governance Problemsin Ontario’s Electricity Sector. C.D. Howe Commentary 261.

April 2008 Laidler, David. “Food and Energy Prices: Why the Bank of Canada Should Remain Focused on the CPI .”C.D. Howe Institute e-brief.

April 2008 Banerjee, Robin and William Robson. “Lifting the Lid on Pension Funding: Why Income-Tax-Act Limits onContributions Should Rise.” C.D. Howe Institute e-brief.

April 2008 Dachis, Benjamin. “Slicing the Pie: Federal Assistance for Provincial Sales Tax reform.” C.D. Howe Institute e-brief.

April 2008 Brennan, Tim. Generating the Benefits of Competition: Challenges and Opportunities in Opening ElectricityMarkets. C.D. Howe Institute Commentary 260.

March 2008 Dymond, Bill, and Michael Hart. “Navigating New Trade Routes: The Rise of Value Chains, and theChallenges for Canadian Trade Policy.” C.D. Howe Institute Backgrounder 259.

February 2008 Poschmann, Finn. “Still High: Marginal Effective Tax Rates on Low-Income Families. ” C.D. Howe InstituteBackgrounder 113.

February 2008 Busby, Colin, and William B.P. Robson. “Off the Mark: Canada’s 2008 Fiscal Accountability Ranking.” C.D.Howe Institute Backgrounder 112.

Février 2008 Busby, Colin, and William B.P. Robson. « Objectifs manqués : le classement 2008 de la responsabilité fiscaleau Canada. » C.D. Howe Institute l’ Institut C.D. Howe, Bulletin de recherche.

February 2008 Busby, Colin. “After the Oil Rush: A Blueprint for Alberta’s Long-term Happiness.” C.D. Howe Institute e-brief.

February 2008 Robson, William B.P., and Finn Poschmann, with Robin Banerjee, Colin Busby and Benjamin Dachis.“Steering Through Turbulence: The Shadow Federal Budget for 2008.” C.D. Howe Institute Backgrounder111.

February 2008 Johnson, David. School Grades: Identifying British Columbia’s Best Schools. C.D. Howe Institute Commentary258.

January 2008 Laidler, David. “Fixing the Exchange Rate: Still a Bad Idea.” C.D. Howe Institute e-brief.

January 2008 Robson, William B.P. “Safe Harbours: Providing Protection for Canada’s Money-Purchase Plan Sponsors.”C.D. Howe Institute Backgrounder 110.

December 2007 Robson, William B.P. “Time and Money: The Challenge of Demographic Change and Government Financesin Canada.” C.D. Howe Institute Backgrounder 109.

CC..DD

.. HHooww

ee IInnssttiittuuttee67 Yonge StreetToronto, O

ntarioM

5E 1J8

Canadian Publication M

ail SalesProduct A

greement #40008848

commentary_263

Documents

resource revenues alberta

fiscal policy

direct resource revenues

resource revenue savings

true impact of resource

alberta government

exhaustible resource

major policy study