Permanent funds: Meaning, Criticisms & Real-World Uses

What Are Permanent Funds?

Permanent funds are a type of governmental fund designed to provide a perpetual source of funding for specific public purposes, primarily through the use of their investment earnings while preserving the original capital. They are a crucial component of fund accounting within the broader category of public finance. Unlike other types of funds, the distinguishing characteristic of a permanent fund is that its principal amount is legally restricted and cannot be spent; only the income generated from investing this principal can be used to support governmental programs or services⁵², ⁵³. This structure ensures principal preservation and offers a sustainable revenue stream for the benefit of current and future generations.

History and Origin

The concept of permanent funds has roots in historical endowments established by governments and non-profit organizations for public purposes⁵⁰, ⁵¹. In the United States, the formal classification of permanent funds as one of the five governmental fund types was introduced through Governmental Accounting Standards Board (GASB) Statement No. 34. This statement, issued by the Governmental Accounting Standards Board, significantly shaped the financial reporting standards for state and local governments.

A prominent example is the Alaska Permanent Fund, established in 1976 through a constitutional amendment⁴⁸, ⁴⁹. Recognizing that its oil wealth was a non-renewable resource, Alaskan residents created the fund to ensure that a portion of the state's oil revenues would provide long-term benefits to its citizens⁴⁶, ⁴⁷. The fund received its first deposit of dedicated oil revenues in 1977, and the Alaska Permanent Fund Corporation (APFC) was created in 1980 to manage its investments⁴³, ⁴⁴, ⁴⁵. The Alaska Permanent Fund exemplifies the commitment to intergenerational equity that underlies many permanent funds.

Key Takeaways

Permanent funds are governmental funds where the principal is legally restricted and preserved indefinitely.
Only the investment earnings from the principal are available for expenditure.
They are primarily used to finance specific public programs or services.
Their structure ensures a sustainable source of funding and promotes intergenerational equity.
Compliance with specific legal and regulatory requirements is essential for their management.

Formula and Calculation

While there isn't a universal "formula" for the overall value of a permanent fund, its sustainability and the amount available for spending are governed by a spending policy. This policy typically dictates how much of the fund's earnings can be distributed annually while aiming to maintain the principal's purchasing power, often factoring in inflation ⁴⁰, ⁴¹, ⁴².

The amount available for distribution (Payout) is commonly calculated as a percentage of a moving average of the fund's market value:

\text{Payout} = \text{Spending Rate} \times \text{Average Market Value}

Where:

Payout: The dollar amount of funds available for expenditure in a given period.
Spending Rate: A predetermined percentage (e.g., 4% to 5.5% for endowments)³⁸, ³⁹.
Average Market Value: The fund's market value averaged over a defined past period (e.g., three years or 12 quarters) to smooth out market volatility³⁶, ³⁷.

This approach balances current spending needs with the long-term preservation of the fund's value.

Interpreting Permanent Funds

Interpreting a permanent fund involves understanding its purpose, the restrictions on its use, and its capacity to generate sustainable income. A well-managed permanent fund signifies a government's commitment to long-term fiscal stability and its ability to provide consistent public services without depleting core assets³⁴, ³⁵.

For financial analysts and policymakers, the key is to assess the fund's spending policy in relation to its investment performance and the economic environment. A spending rate that is too high might jeopardize the principal preservation objective, while one that is too low might not adequately serve current public needs. The fund's overall asset allocation and risk management strategies are critical indicators of its health and long-term viability³³.

Hypothetical Example

Imagine the city of Evergreen establishes a permanent fund to perpetually finance its public library system. An initial donation of $10 million is made to the Evergreen Library Permanent Fund. According to the city's ordinance, only the investment earnings from this fund can be used, and the $10 million principal must remain intact.

The fund's spending policy dictates an annual spending rate of 4.5% of the average market value over the preceding five years.

Year 1: The fund's initial market value is $10 million. Investment earnings for the first year are $500,000.
Year 2: The market value grows to $10.8 million. The average market value for the calculation (simplified for this example, assuming only the initial and current year for average) would be $($10,000,000 + $10,800,000) / 2 = $10,400,000$.
Available Payout: $4.5% \times $10,400,000 = $468,000$.

This $468,000 is the amount the Evergreen Library System can use from the permanent fund's earnings for its operations, new book acquisitions, or programs, ensuring the fund's core principal continues to grow or at least maintain its value over time.

Practical Applications

Permanent funds appear in various real-world scenarios, predominantly in public sector finance and large-scale endowment management:

Governmental Programs: Many states and local governments utilize permanent funds to support vital public services like education (e.g., Texas Permanent School Fund, Texas Permanent University Fund), infrastructure, or healthcare, ensuring long-term financial stability for these initiatives³².
Sovereign Wealth Funds: Larger permanent funds, particularly those derived from natural resource revenues (like oil or minerals), often function as sovereign wealth funds. These funds play a significant role in national fiscal policies and global investment markets. The Santiago Principles, developed by the International Forum of Sovereign Wealth Funds in collaboration with the International Monetary Fund (IMF), provide a globally accepted framework for the governance, investment, and risk management practices of such funds²⁸, ²⁹, ³⁰, ³¹.
Community Foundations and Endowments: Non-profit organizations and universities often manage endowment funds that share structural similarities with permanent funds, focusing on principal preservation and using only investment income for ongoing operations or specific programs²⁵, ²⁶, ²⁷.
Intergenerational Transfers: Permanent funds are a mechanism for governments to save non-renewable resource wealth for future generations, transforming finite assets into enduring financial capital²⁴.

Limitations and Criticisms

While designed for long-term stability, permanent funds face certain limitations and criticisms:

Flexibility Constraints: The legal restrictions on the use of the principal and, at times, the earnings, can limit a fund manager's flexibility to respond to unforeseen circumstances or economic downturns²³. This can be particularly challenging if the fund's prescribed spending policy does not allow for sufficient adjustments during periods of low returns or high inflation.
Investment Risk: Although the principal is preserved, the value of the principal, and thus the amount of distributable earnings, can still fluctuate due to market risk. The fund's investment portfolio is subject to market movements, credit risk, and liquidity risk, which can impact its overall performance and the actual payout amounts²².
Governance Challenges: Ensuring proper governance, transparency, and accountability is crucial. Mismanagement or political interference can undermine a permanent fund's objectives, potentially leading to lower returns or the erosion of its real value over time.
Low Payout in Perpetual Models: Strict principal preservation with a low spending policy (e.g., the "4% rule" in retirement planning, though recent research on safe withdrawal rates has pushed it closer to 5% for individuals²¹) might result in payouts that are considered insufficient to meet present needs, especially if the fund's growth barely keeps pace with inflation.

Permanent Funds vs. Endowment Funds

While closely related and often sharing the goal of perpetual funding, there are key distinctions between permanent funds and endowment funds.

Feature	Permanent Funds	Endowment Funds
Primary User	Governmental entities for public benefit (e.g., states, cities)	Non-profit organizations (e.g., universities, hospitals, charities)
Legal Basis	Often established by specific legislation, constitutional amendment, or GASB rules²⁰	Typically established by donor stipulations, trust agreements, or board designations (quasi-endowments)¹⁹
Purpose	Support general governmental programs or broad public services¹⁸	Fund specific activities of a non-profit, such as scholarships, research, or operational costs¹⁶, ¹⁷
Principal	Legally restricted; cannot be spent¹⁴, ¹⁵	Generally intended to be permanent, but can include "quasi-endowments" where principal can be spent by board decision¹², ¹³
Accounting	Accounted for under governmental fund accounting standards¹¹	Accounted for under non-profit accounting standards

The fundamental difference lies in their primary beneficiaries and the specific legal and accounting frameworks governing them. A permanent fund specifically refers to one of the governmental funds categories, while an endowment fund is a broader term that includes those held by private non-profit organizations¹⁰. Both emphasize long-term growth and responsible investment earnings utilization.

FAQs

How does a permanent fund differ from a regular investment fund?

A permanent fund is unique because its principal amount is legally required to remain untouched; only the income it generates can be spent⁹. Regular investment funds, such as mutual funds or exchange-traded funds, generally allow for both the principal and earnings to be spent or withdrawn by investors at their discretion.

Who benefits from permanent funds?

The primary beneficiaries of permanent funds are the citizens or the public at large, as the funds are established to support governmental programs, services, or provide a public dividend ⁷, ⁸. This ensures a continuous flow of resources for public welfare.

How is the amount that can be spent from a permanent fund determined?

The amount available for spending is typically determined by a spending policy or rule, which calculates a percentage of the fund's average market value over a period⁵, ⁶. This helps to stabilize the payout amount and protect the fund's value from short-term market fluctuations.

Are permanent funds immune to market downturns?

No. While permanent funds aim for stability by preserving principal and utilizing diversification strategies, their underlying investments are still exposed to market risk. A significant market downturn can reduce the fund's market value, which in turn can lower the amount of investment earnings available for spending⁴.

What is the role of inflation in managing a permanent fund?

Inflation is a crucial factor because it erodes the purchasing power of money. Effective permanent fund management often includes strategies to ensure the fund's principal grows at least at the rate of inflation, preserving its real value and enabling consistent payouts over the long term¹, ², ³.