Using the Legacy Fund to Eliminate Income Taxes Would Not Make North Dakota Like Alaska

During the last legislative session there was a bill, passed by the state House by a wide margin but shot down by the Senate, which would have used revenues from the state’s Legacy Fund to reduce and eventually eliminate state income taxes.

I interviewed the sponsor, state Rep. Craig Headland (R-Montpelier), about the legislation earlier this year.

The key term – one which has apparently flown over the head of the Grand Forks Herald editorial board – is “revenues from the state’s Legacy Fund.”

More on that in a moment.

Critics of Headland’s proposal suggested that it would make North Dakota too dependent on volatile revenues from taxes on oil activity, which in addition to interest earned on investments are the primary source of the cash which flows into the Legacy Fund. Indeed, that’s what the Herald argues in an editorial today, suggesting that using the Legacy Fund to eliminate the income tax would put North Dakota in the same sort of fiscal mess Alaska current faces.

[mks_pullquote align=”left” width=”300″ size=”24″ bg_color=”#ffffff” txt_color=”#000000″]These sentences are frustrating, because they speak to a deep misunderstanding of how North Dakota’s budget actually operates.[/mks_pullquote]

“North Dakota and Alaska are so similar. Both have roughly 750,000 residents and both rely heavily on oil dollars to pay many of the bills,” the Herald writes. “But as Alaska’s financial stool features a single stilt upon which the state precariously balances, North Dakota’s stool has multiple legs (oil, income and sales taxes) and provides a bit of sturdiness to the residents who live here. Alaska’s problems are a bellwether for North Dakota. It would be wise to heed the message.”

These sentences are frustrating, because they speak to a deep misunderstanding of how North Dakota’s budget actually operates.

The state’s general fund really isn’t all that dependent on oil tax revenues. In fact, revenues from direct oil taxes are capped in the general fund. Most of those revenues flow into the state’s special funds or “buckets” (to use the parlance of the Legislature) of which the Legacy Fund is one. Sometimes those funds may be used to prop up spending, or to fill out the general fund, but for the most part North Dakota’s day-to-day government expenses are paid for by the sales tax, the income tax, and (mostly locally) the property tax.

The turn down in oil activity a few years back did cause headaches for the general fund budget, but that was mostly because of the drop in sales tax revenue and, to a lesser extent, income tax collections. If the turn down had only impacted direct oil and gas tax revenues, the impact on general fund spending would have been marginal. The state would have only seen a slowdown in the revenues flowing into the special funds.

North Dakota absolutely needs more economic diversity, so that our state’s economy isn’t riding the roller coaster of commodity prices, but we have plenty of diversity when it comes to how we tax.

Nor would that change if Legacy Fund revenues were used to replace the income tax. Those saying it would make us more dependent on oil taxes are ignoring that it would be the revenues the Legacy Fund generates from its various investments which would be used to replace income taxes. The Legacy Fund principal balance is made up of oil tax deposits, yes, but even if oil activity in the state ceased entirely tomorrow and those deposits dried up the Legacy Fund would still have billions and billions of dollars in it which would continue to generate its own revenue stream through investment.

That revenue stream, and not oil taxes, is what would replace the income tax.

Those investment revenues can still go up and down, sure, but the volatility would be no greater than what we see already with the income tax which, as I’ve already mentioned, can go up and down based on the variances in the state’s economy.

Alaska, meanwhile, is in a much different situation. They have historically used their Permanent Fund – which is more comparable to North Dakota’s Common Schools Trust Fund, not the Legacy Fund, made up as it is from royalties from oil development on state-owned land as opposed to taxes – to make annual payments to Alaskans. The food fight in the state now is whether or not to pay citizens a bigger check, or devote that money to shore up the state’s budget and avoid cuts.

That political dynamic is why it’s a terrible idea for the government to just start doling out money to citizens.

What Rep. Headland proposed was very different, leveraging Legacy Fund investment earnings to buy down the income tax and thus relieve burdens on all working North Dakotans.