The Tax Cuts and Jobs Act of 2017 (TCJA) was touted as a way to decrease the tax burden of the American people and increase the productivity of the American economy. Central to the TCJA was the cap on exemptions of deducting interest paid on home mortgages and on deducting state income taxes from an individual’s federal income tax. The passage of the TCJA has hurt school funding for the so-called blue states in that the blue states traditionally have a higher tax rate to support their K1 to K12 school systems. The TCJA did not hurt the red states as much since many red states have Sovereign Wealth Funds (SWF) which typically fund the K1 to K12 school systems and so do not need the additional income from a state income tax to finance their educational systems.
Not considered in the TCJA was that all investment income derived by state SWFs is not taxable income. The Republican Party crafted the TCJA to restrict educational benefits in typically Democratic states, to economically punish the blue states for their economic choices, and reducing the blue-states ability to fund adequate education for their children. By maintaining the tax-exempt status on the investment income of state SWFs, the Republican Party maintained the ability of primarily Republican states to continue to fund the education of their children, rather than to promote the economic security of the American people as a whole.
There Are 21 Sovereign Wealth Funds
At the Associate State Level of the Union
While there are 21 SWFs at the associate state level of the Union, there are only 20 states who have SWFs, as Texas has two funds.
The first SWFs began with the Land Ordinance of 1785 and the Northwest Ordinance of 1787. The Ordinance of 1875 provided that western lands were to be surveyed and divided into townships of seven square miles, and then divided into 36 sections. For each township the center lot, described as lot number 16 for each township, should be reserved for the maintenance of public schools within each township.
The Northwest Ordinance placed in being a more formal mechanism by which states were able to apply for entrance as an associate state in the Union. Each territory applying for state hood would need to have an Enabling Act which would set out the specific land grant for the maintenance of a public-school system. These early attempts to provide for a public-school system did not provide for a legal trust fund, for the maintenance and investment of any income derived from these plots of land. The incoming states also had considerable leeway in deciding what to do with these specific land grants and how to manage them.
Many states immediately sold these parcels of land to raise money for the establishment of the public-school system in the new state. It would not be until 1835 that the territory of Michigan established the first permanent fund. Other states entering the Union followed the Michigan example, but it was not until 1875 that the federal government specifically spelled out to the territories entering the Union on how they would need to exploit the lands for the use of public education.
Severance tax funds began to appear in the 1930’s when the state of New Mexico began to use the concept of taxing the extraction of mineral wealth from state public lands. On March 1, 1937, the state of New Mexico began imposing a severance tax on mineral wealth extracted from state lands. As of 2018 the New Mexico had a valuation of $23 billion. 75% of the investment income from this fund is allocated to New Mexico’s education system, and the remaining 25% is used to for other state obligations.
Many oil producing companies felt that the severance tax was unconstitutional and began a series of lawsuits. In 1981 the Supreme Court of the United States ruled in Commonwealth Edison versus Montana that the state of Montana had the right to impose such a tax on oil companies.
The states which have a SWF for educational purposes and to offset costs to the state government are listed here:
State Primary Source of Income Inception Date Valuation 10/21* Earnings *
Louisiana Minerals 1986 $6.5 billion Unknown
Montana Oil, Investment, XXXXXX $62 million NA
Grazing, Agricultural 1889
Nebraska Ag leases 1867 $536 million NA
Nevada Land sales, estates that escheat and penal laws and fines
Oklahoma Oil, Gas and Investments 1906 $1.8 billion Unknown
Texas UF Oil and Gas 1876 $31.9 billion Unknown
Wisconsin Unclaimed and XXXXX XXXXXXXXX
Escheated Property 1848 $31 million NA
(* The figures given in this article are based on the best information available to the public. Several of the SWFs are so opaque that it was impossible to provide earnings even after contacting the SWFs directly. Where no valuation or earnings of a SWF was found, the information used was taken from the paper: North American Dream: The Rise of U.S. and Canadian Sovereign Wealth by Dr. Paul Rose published on May 6, 2014 at the Moritz College of Law at Ohio State University)
Domestic Sovereign Wealth Funds
And Investment Income Is Not Taxable
For decades the so-called red states have campaigned against allowing the richer blue states for being able to deduct their state income taxes and interest payments on homes from their federal income tax. With the passage of the TCJA, these deductions were done away with and a single $10,000 cap imposed on primarily the blue states. The TCJA did not take into consideration the tax exempt status of the SWFs in the US, or the profits from the SWFs, thus making this wealth invisible to the federal government.
When the federal government decides to allocate funds to the associate states of the Union, the primary factor in this decision making is based on need.
ELEMENTS INCLUDED IN ALLOCATION FORMULAS
Elements included in formulas vary widely among the programs currently active. Most programs use one or more of the following:
A direct or indirect measure of need, such as the number of school age children in poverty, the number of overcrowded housing units in an area, or the number of reported cases of AIDS.
A measure of the capacity or capability of an area to meet the need
from state, local, or private funds. Typical measures used are per capita income and total taxable resources.
A threshold, which calls for some minimum level of need before an area is eligible for any funds at all under the program. In some programs, thresholds are used to target resources to the areas with the greatest need.
A minimum amount to be received by each state or other jurisdiction.
A hold-harmless provision, which limits decreases in amounts received by areas from one time period (usually a fiscal year) to the next.
The inclusion of such special features sometimes requires use of relatively complicated iterative procedures to determine the allocation of a fixed total appropriation to eligible jurisdictions.
Since the accumulated wealth of the SWFs are invisible to the federal government when the federal government allocates tax revenue among the associated states, the current tax policies punishes those states with high taxation rates and rewards those states with low taxation rates. This means that the majority of the federal tax re-distributed goes from blue states to red states.
The Republican states by their actions in making their SWFs and income tax free, and at the same time accessing the treasury of those states who tax themselves to provide a good education to their population are in a position to have their cake and eat it too.