Government Revenue Volatility in Alberta

Abstract

The Alberta government is heavily exposed to energy price volatility as it relies to a great extent on revenue derived from the production of oil and natural gas. Energy prices change substantially and unpredictably, causing large and uncertain movements in revenues. Adjusting to these movements typically involves economic, social and political costs. Alberta government revenues are considerably more volatile than the revenues of other provinces, but Alberta’s own-source revenues less royalty payments are of similar size and volatility as those of other provinces. Several methods to reduce the volatility of revenues are assessed. An often-suggested method, tax base diversification (for example, use of a retail sales tax), is shown to have a minor effect on overall revenue volatility since Alberta’s royalty revenues are such a large share of total own-source revenues. Revenue smoothing using futures and options markets can be expensive, is associated with significant political risks, and cannot eliminate all revenue volatility. The Canadian dollar tends to appreciate (depreciate) when energy prices rise (fall), so exchange rate movements have smoothed Alberta government revenues, although not by a large amount. A simulation using Alberta data shows that a revenue savings fund could significantly reduce revenue volatility. This type of fund leads to greater revenue stability because the revenue it contributes to the budget in any particular year is based on revenues averaged over prior years. Revenue uncertainty is also reduced with a savings fund since future revenue depends on known past contributions.government revenue volatility; energy prices; tax base diversification; government savings fund