Make an Allocation of Certain Investment Income from the Permanent School Fund to the Available School Fund

The Comptroller should renew the Memorandum of Understanding with the Texas Education Agency to increase the allocation of certain investment income from the Permanent School Fund to the Available School Fund.


Background
The Permanent School Fund (PSF) was created as a perpetual endowment to support public free schools. Early constitutional provisions in Texas gave both land and money as the basis for the PSF. The fund s original assets were designated to stay in the principal, or corpus, of the PSF and the income generated from these assets was designated to go to the Available School Fund (ASF) to pay for the cost of operating public schools in the state.

An 1854 law dedicated $2 million from the settlement of a boundary dispute with the United States government to the PSF. The current constitution, adopted in 1876, also dedicated certain lands and the proceeds from those lands to the PSF. More than 46.5 mi llion acres of land have been granted to the PSF, including the mineral interests of 7.1 million acres. 1

PSF principal growth can come from two sources of revenue. One source is income from General Land Office (GLO) managed land in the form of mineral royalties and sales of PSF-dedicated land. The other source of PSF principal growth is capital gains income f rom the growth in the value of equity (stock) investment. Capital gains can be both realized and unrealized. Realized capital gains are those that occur when a stock is sold, and the price is higher than when it was bought . Unrealized capital gains are those that occur before a stock is sold when the market value of a share of stock is higher than when it was bought.

Income from the PSF is allocated to the ASF for distribution to school districts on a per-student basis. This income consists primarily of interest on bond investments, dividends from stock investments and land lease income.

Investment opportunities have expanded greatly since the original PSF was created. The wealth available for investment has grown as well . Much of the original land has been sold and the proceeds from the sales have been invested in securities such as stocks and bonds. The royalties deposited in the PSF from mineral leases are also invested in securities. Over time, virtually all the wealth in the PSF has been converted into securities.

The principal of the PSF grew tremendously during the decade of the 1980s. The PSF had a market value of $5.8 billion on September 1, 1985 (fiscal 1986). The market value of the fund on September 1, 1992, wa s $10.9 billion, an increase of 87.6 percent in seven years (Table 1). 2 Investment returns during the 1980s, including capital gains, were very high, well above the historical market average rate of return. This growth was supplemented by the money received from the GLO lands. The driving force behind the large amount of mone y from the GLO was the high price of oil and natural gas produced on PSF land, particularly during the early 1980s.

Table 1
Permanent School Fund Assets 3
(Market Value, in millions)

Payment to
Fiscal Beginning Mineral Net Capital Ending Available
Year Balance Income Gains Balance School Fund

1986 $ 5,835 $408 $286.5 $ 7,836 $652
1987 7,836 171 166.1 8,128 551
1988 8,128 183 144.5 7,715 573
1989 7,715 192 148.6 9,091 615
1990 9,091 179 270.3 8,931 675
1991 8,931 176 175.1 10,228 700
1992 10,228 145 342.2 10,945 739

Source: Texas Education Agency, The State Permanent School Fund Annual Report, 1986-92.

Receipts from the GLO were at record levels during the early 1980s . In fiscal 1981, PSF receipts from the GLO reached a peak of $509.5 million. That same year, $217.7 million was paid into the ASF. Payments to the ASF during the decade did not exceed the income from the GLO in any year until fiscal 1985. Net capital gain s from PSF equity investment in fiscal 1985 totaled $216.3 million.

Capital gains began to play a major role in PSF growth in the middle of the 1980s, reaching a peak of $286.5 million in fiscal 1986. 4 This increase occurred at the same time as the decr ease in oil and gas royalties from the GLO. In fiscal 1987, PSF receipts from GLO dropped to approximately $171 million and have remained relatively constant since that time.

The combination of mineral royalties and net capital gains contributions to the principal of the PSF accounted for enormous growth in the fund during the 1980s. The highest single-year growth in the PSF occurred in fiscal 1986 when the book value of the fu nd grew by nearly $697 million, nearly all of which was accounted for by mineral royalties and capital gains. In fiscal 1966, only 20 years earlier, the book value of the entire principal of the PSF was $681 million. 5 The market value of the fund, by comparison, has grown even more rapidly. The market value increase was approximately $2 billion during fiscal 1986 alone.

During the First Called Session of the 72nd Legislature in July 1991, the State Board of Education entered into a Memorandum of Understanding with the Comptroller of Public Accounts to increase income paid to the ASF b y $50 million over normal income production during the 1992-93 biennium. To do this, the PSF investment portfolio was altered so that sales of equities and subsequent purchases of fixed income securities (bonds) in measured amounts would generate the addit ional $50 million during the biennium. By substituting the bond investments for the stock investments, bond interest income was received during the biennium that exceeded the dividend income from the stocks.

The PSF is generating larger amounts of revenue for the ASF than ever before. In fiscal 1992, $739 million was paid to the ASF. The growth of the PSF in recent years makes it able to sustain a continued high level of support for public education.


Recommendation
The Legislature should direct the Comptroller and the Texas Education Agency (TEA) to renew the Memorandum of Understanding to increase the allocation of investment income from the Permanent School Fund (PSF) to the Available School Fund (ASF) by $50 milli on over the Comptroller s official es timate of PSF interest, dividend and other revenue earnings as reported in the Biennial Revenue Estimate for 1994-95 or, if applicable, in the latest succeeding official revenue estimate issued by the Comptroller prior to the date of the agreement.

The additional income generated by the agreement would be added to the revenue available for spending on education during the biennium. The TEA should adjust its investment portfolio, if needed, so that the additional revenue earned is spread evenly betwee n the two years of the biennium.


Implications
Approximately $50 million would be made available for spending on public school education in the state. Since ASF spending is an offset to General Revenue Fund spending, approximately $50 million could be used for general spending purposes as authorized by the Legislature. Any increase in spending from the ASF would relieve pressure from the Foundation School Program on the General Revenue Fund.

The PSF investment portfolio would need to be altered as needed to g enerate the additional short-term revenue. If market conditions remain fairly constant between the current biennium and the 1994-95 biennium, little adjustment in the portfolio mix would be needed. If market changes dictate different investment returns, ad ditional investment adjustments would be required.


Fiscal Impact
Renewal of the Memorandum of Understanding between the Comptroller and the Texas Education Agency would generate an additional $50 million in revenue for ASF spending during the 1994-95 bi ennium. ASF revenue is distributed to local school districts based on average daily attendance. There would be no additional revenue after fiscal 1995.

Fiscal Gain to the Change in
Year Available School Fund 002 FTEs

1994 $25,000,000 0
1995 25,000,000 0
1996 0 0
1997 0 0
1998 0 0

Because of the operation of the state fund structure, this change would have the net effect of increasing the amount available for certification from the General Revenue Fund.




Endnotes
1 Texas Education Agency, Committee on the Permanent School Fund, Ensuring The Future of Texas: The Permanent School Fund, Austin, Texas, April 1992.
2 Texas Education Agency, Permanent School Fund Staff, Annual Report (1986-92).
3 Ibid.
4 Comptroller of Public Accounts, Annual Cash Report (1986-92).
5 Texas Education Agency, Permanent School Fund Staff, Annual Report 1992, p. 16.
6 Ibid, p. 4.