California Should Use Surplus to Establish a Sovereign Wealth Fund

May 26, 2022 Updated: May 26, 2022

Commentary

The California legislature is trying to figure out what to do with the cornucopia of wealth from the expected $97.5 billion surplus for fiscal year 2022-23, which begins on July 1. Here’s a new idea to throw into the mix: Create a sovereign wealth fund.

The Investopedia definition: “A sovereign wealth fund is a state-owned investment fund comprised of money generated by the government, often derived from a country’s surplus reserves. SWFs provide a benefit for a country’s economy and its citizens. The funding for a SWF can come from a variety of sources. Popular sources are surplus reserves from state-owned natural resource revenues, trade surpluses, bank reserves that may accumulate from budgeting excesses, foreign currency operations, money from privatizations, and governmental transfer payments.”

In California’s case, the money would come from the vast wealth from the taxes paid after the increase in valuations of tech companies, especially in Silicon Valley, San Francisco, and Los Angeles.

California’s Rainy Day Fund, set up by Proposition 2 in 2014, is a quasi-SWF. According to Gov. Gavin Newsom’s May Revision to his budget proposal, it currently contains $23.3 billion and is “now at its constitutional maximum” of 10 percent of general-fund revenues. There’s also another $9.5 billion in the Public School System Stabilization Account and $900 million in the Safety Net Reserve. These are valuable and would be used should the surpluses of recent years turn into deficits, as has occurred in the past during recessions.

The state also operates large pension funds, which will be addressed below. But those exist for the specific purpose of paying the pensions of qualified employees.

A California SWF would be different, paying dividends to go into the state general fund. The money then could be used to pay for programs or to reduce taxes. For example, suppose all $97.5 billion of this year’s surplus were put into a new California SWF. Next, suppose it rose in value by 10 percent across fiscal year 2022-23. Then it would pay $9.75 billion into the general fund for the next year, 2023-24.

A modification might to be to split the dividend: half to the general fund, or $4.9 billion; the other half reinvested into the SWF, $4.9 billion. That would raise the SWF’s value to $102.4 billion. The fund also could increase in value with future surpluses being put into it.

If there’s a bad year with the fund declining, then there would be no transfer to the general fund.

Complications

A California SWF would have to overcome some complications. One is Proposition 98, which mandates 40 percent of all new revenues go to K-12 education. It could be modified so the 40 percent rule does not apply to surplus funds put into the SWF, but only to what is paid out. The schools still would get the money, and more of it as the fund grew, just not right away.

Another complication could be the legislature using the SWF to manipulate markets. Something similar already happens with the California Public Employees Retirement System banning investments in tobacco companies, costing it at least $3.6 billion over the past two decades. The SWF would have to be set up so it invests in all legal investments. Alternatively, it could be set up to invest only in the S&P 500, insulating it from legislative legerdemain.

The retirement funds of public employees also could bring complications because they are underfunded. If they default on their obligations, retirees might go after the SWF’s money. Their status as of their most recent valuations:

  • CalPERS, as of its June 30, 2021 report, was worth $477 billion, but only 80 percent funded.
  • The California State Teachers Retirement System had a valuation on Sept. 30, 2021 of $317 billion and a 69.2 percent funding ratio.
  • University of California Pension’s valuation was $91 billion on June 30, 2021, with an 83 percent funding ratio.

Other SWFs

According to the SWF Institute, the current top SWFs are:

  • $1.3 trillion: Norway Government Pension Fund Global;
  • $1.2 trillion: China Investment Corp.;
  • $738 billion: Kuwait Investment Authority;
  • $709 billion: Abu Dhabi Investment Authority;
  • $690 billion: GIC Private Ltd. (Singapore).

In North America, using other sources, the top funds are:

  • $109 billion: Alberta Investment Management Corp.;
  • $79 billion: Alaska Permanent Fund Corp.;
  • $69 billion: University of Texas Investment Management Co.;
  • $48 billion: Texas Permanent School Fund;
  • $34 billion: New Mexico State Investment Council.

Eureka!

If other states and Canadian provinces can establish SWFs, why can’t California? Starting with even $10 billion from this year’s $97.5 billion surplus would be something. Then plan for what to do with future surpluses.

The reason why the oil countries set up such funds is because they know some day the liquid gold will dry up. Then how will they fund their welfare states without their people starting revolutions?

California should expect the vast wealth currently generated by our world-leading tech sector won’t last forever. Indeed, looking at the exodus of Tesla and other firms shows there are storms on the horizon. The tech gold rush, too, someday will end.

Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.

John Seiler
John Seiler is a veteran California opinion writer. He has written editorials for The Orange County Register for almost 30 years. He is a U.S. Army veteran and former press secretary for California state Sen. John Moorlach. He blogs at JohnSeiler.Substack.com