'We Are All Millionaires Now': Norway's Astounding Fiscal Reserve

The oil and gas reserves under the Norwegian continental shelf are being transformed into financial reserves for future generations. No other government in Europe or North America is saving its petroleum wealth for future generations to nearly the same extent.
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The financial position of the Norwegian government is astonishingly strong. While most other national governments in Europe and North America, especially in recent years, have been posting sizable annual budget deficits and accumulating additional debt, Norwegians have seen their government post sizable annual budget surpluses and add to a rapidly growing fiscal reserve - popularly known as the oil fund - that now has a market value (almost $850 billion) more than 1.5 times larger than Norway's GDP! "We are all millionaires now," declared a Norwegian acquaintance, noting that the market value of the oil fund has risen beyond five trillion krone - for the five million Norwegians. A few days ago, the central bank of Norway announced that in 2013 the market value of the giant oil fund increased by more than 1.2 trillion Norwegian krone (about $200 billion), partly from returns on the fund's investments, partly from new capital transferred by the government to the oil fund, and partly due to a weaker krone exchange rate (the oil fund's investments are placed outside Norway in other currencies).

The oil and gas reserves under the Norwegian continental shelf are being transformed into financial reserves for future generations. Several other political communities in Europe or North America are substantial oil and gas producers from public land, but no other government in Europe or North America is saving its petroleum wealth for future generations to nearly the same extent.

The British continental shelf abuts that of Norway, and for many years Britain was a larger offshore producer than Norway. But Britain has no investment fund saving in another form the wealth represented by these non-renewable resources. The revenue from oil and gas development has been spent. The story is similar for oil and gas lifted from Federal land in the United States, notably in the Gulf of Mexico. The same is true for the Mexican government, which uses current petroleum revenue to pay for a large part of its annual budget.

The closest counterparts of Norway's oil fund in Europe or North America are the investment funds created with petroleum revenue in Alberta (current population roughly four million) and Alaska (current population almost 750,000). Both of these funds were established in the mid-1970s with the great surge in oil prices. But they are now far smaller in market value than the Norwegian fund, and are used in different ways. At the end of 2013, the Alberta Heritage Fund had a market value of C$17.3 billion (about the same in US$). The Alaska Permanent Fund reached a market value of $50 billion late last month. As noted above, the value of the Norwegian oil fund is approaching $850 billion.

Alberta and Alaska have allocated only a small portion of their oil and gas revenues over the years to their respective investment funds, choosing instead to spend most of this revenue and to reduce taxes - and thus to remain dependent on the vagaries of oil prices and production. Alaska chose to abolish its state income tax in 1980 and has no sales tax, and its gasoline tax is the lowest of all the fifty states. The government of Alaska depends on current petroleum revenue for over 90% of its unrestricted revenue. In Alberta, "successive provincial governments have used abundant royalty revenues to cut non-oil taxes....Alberta has the lowest income taxes, the lowest consumption taxes, and the lowest corporate taxes - the lowest overall taxes of any jurisdiction in Canada." Alberta is less dependent than Alaska, but fluctuations in petroleum revenue still make for considerable uncertainty in the province's finances.

For many years the Norwegian government has allocated all of its net oil and gas revenue to the oil fund - and maintained relatively high income, consumption and gasoline taxes. Thus the government budget is not at all dependent on current petroleum revenues. In preparing the annual government budget, roughly speaking, projected non-oil revenues can fall short of projected expenditures with the gap to be filled by the average real return on the oil fund's investments (not current petroleum revenue). When this guideline was set in 2000, the average real return was imagined as 4% of the market value of the fund. The guideline was to be interpreted flexibly, depending on economic circumstances. Given the rapid rise in the value of the fund (and lower real returns), the policy debate is tending toward a lower guideline - perhaps 3%. With an oil fund 1.5 times larger than Norway's GDP, the 4% guideline would mean 6% of GDP!

The relative restraint of Norwegians with regard to tax reductions now means that in the future taxes will not need to rise (or other expenditures decline) as much as they otherwise would to cover pensions and other costs of an aging population, a long-term financial challenge for almost all governments in Europe and North America. To heighten recognition of this long-term benefit of the fund and protect it from raids for other purposes, its formal name was changed in 2006 to Government Pension Fund Global. This giant fiscal reserve is not earmarked for any specific obligations, but the new name highlights its imagined long-term purpose. Once again, the Norwegian government is in an astonishingly strong financial position.

The choices along the way that have brought about this very impressive collective accomplishment grow out of the functioning of Norwegian society and governance (and some good luck), but that is a story for another day.

Restraint in demanding tax reductions reflects a relatively strong sense of the importance, competence and integrity of the Norwegian government as an active instrument of the national political community, also reflected in the Norwegian government's direct participation in oil and gas development - another story for another day.

The very success of the oil fund has brought new challenges - yet another story for another day. It is hard to be a passive investor when you have become the largest sovereign wealth fund in the world. How will traditional Norwegian values of hard work and modest lifestyles change over time as the society comes to see itself as very rich?

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