Go with the Flow

Should Alaska Put its Wealth to Work?

Medium Grind -- News and Analysis

About this time last year the Senate majority caucus held its first press availability of the 29th Alaska State Legislature. The financial situation was looking bleak. Some tough decisions were in the offing, we were told. Republican Senator Pete Kelly, a Finance Committee co-chair took the reporters in the room to school. He wanted to make one thing clear, and he wanted to make sure we got it, because our reporting needed to be accurate. Alaska is not facing a budget deficit, Kelly admonished, but our dilemma was, rather, a revenue shortfall. Alaska can’t do deficit spending he said. We have to balance the budget. Fair enough, but then legislative leadership attacked the problem exactly as if it was a deficit, rather than a revenue shortage. They cut and cut, and they didn’t raise a dime of revenue.

Most of the cutting was directed by Governor Bill Walker, and it came in the form of freezing the so-called mega projects and hacking capital spending down to nearly zero. It was a lot of money, but you can only cut it once. The legislature cut more out of the operating budget than Walker had originally proposed; about $350 million total. At this year’s opening press availability on Tuesday, Kelly said we need to do at least that again. The state faces a $3.6 billion deficit. You could keep cutting $350 million a year until the government shut down and you’d still be about a billion in the hole. So ... tough decisions are in the offing.

Some legislators, mostly Democrats, would prefer to go back to the old well and pump the major oil producers for a solution, but someone took the handle. It’s true part of the governor’s proposed fiscal plan includes reducing oil tax credits and a few other minor tax tweaks, but at current prices, and at prices expected by most experts for the foreseeable future, it’s just not near enough. In 2015 Sen. Bill Wielechowski, an Anchorage Democrat, said he could get $2 billion out of the oil industry by applying North Dakota’s oil tax structure here. In fact, you could get about $500 million more from them at $50 per barrel or so. Oil is currently at about $30/bbl. Add another $500 million from reforming tax credits and you’ve narrowed the fiscal gap, but you’re still far from closing it. For now the legislature can balance the budget with its ample, but dwindling, savings and still do nothing about revenues for maybe two years. Over the summer Senator Lyman Hoffman said he expects that’s exactly what the Legislature will do, largely because it’s an election year, and that has a way of weakening spines. Hoffman is a Bethel Democrat who caucuses with the Republican majority.

So, is that it? Are we broke after two years? Most other states would love to be as broke as Alaska. Even after recent stock market wind sheers Alaska’s Permanent Fund is sitting on about $49 billion. That money can’t be touched by the Legislature, but it generates earnings that can. In fact, it’s easier to spend the Permanent Fund Earnings Reserve than it is to spend the $7 billion in the Constitutional Budget Reserve. Easier legally, but it’s a political bitch.

The governor’s plan calls for a restructuring of the Permanent Fund that would, for the first time in Alaska’s history, use some of the fund’s earnings to pay for government. It would also reduce PFD amounts. That will be the source of intense debate, exploding comments threads and self flagellation in the Capitol and across the state.

So, what does the state's cash flow look like now, and what are the proposed options? The following diagrams will provide a glimpse.

The diagram above shows the way the state currently manages its money. Oil taxes and 75 percent of oil royalties flow into the General Fund along with non-oil revenues, which are pretty small. About 25 percent of the oil royalties go to the Permanent Fund principal. The Permanent Fund generates earnings from its investments. Some of the earnings are used to inflation-proof the fund, some are used to pay Alaskans’ dividends; what’s left over goes into the Earnings Reserve Account ... and sits. It’s about $7 billion right now.

The General Fund takes what it earns from oil and other revenue sources and uses it to pay for government. As it turns out oil is a very volatile commodity to build your budget on, so some years are fat and some years are lean. It’s hard to run a stable government that way, so in 1992 a constitutional amendment established the Constitutional Budget Reserve. The fund is intended to give the Legislature a pot of money to go to in lean oil revenue years – then they’re supposed to pay it back in the flush years. The CBR was initially filled with money largely received from the settlement of large oil-related legal cases. It has also been replenished by legislative appropriations from the General Fund. There are no significant external sources available to fill the CBR now, and the GF is broke. There’s something less than $7 billion in the CBR now. If the Legislature uses it to pay the bills, as it did last year, they’ll empty it in two years. And that’s how the cash flows now, more or less.

The diagram above shows the governor’s Sovereign Wealth Fund proposal currently before the Legislature. As you can see, it’s a whole other kind of plumbing. In Gov. Walker’s plan oil taxes would flow into the Permanent Fund, along with 50 percent of oil royalties. The other 50 percent of royalties would pay for dividends. That would drop individual dividends significantly below last year’s record amount, but would still be in range of the long-term average. The governor will guarantee a $1,000 dividend the first year to soften the blow. Part of the idea is that dividends were supposed to represent Alaskans’ share of the value of their oil resource. The way dividends are paid now has nothing to do with oil – it’s a function of the value of the Permanent Fund. The debate will lead to dirty looks and leg wrestling.

The General Fund will directly receive non-oil revenue. That’ll be enough to buy light bulbs for several schools. The rest of the money for government will come from the fading CBR, from a few other taxes and such and from a transfer from the Permanent Fund Earnings Reserve to the General Fund – something like $3 billion.

It’s a complete revision of the way Alaska funds government, and it’s going to change people’s dividends. The governor calls it a heavy lift. It’s at least that. Walker also includes a suite of other taxes and revenue sources that are overviewed in a separate post.

There actually is something like a middle ground. Before last session Sen. Lesil McGuire, an Anchorage Republican, introduced SB 114. It has been described as a Percent of Market Value plan (POMV), but it’s really not. The above diagram shows that SB 114 would continue to feed oil tax and non-oil revenue into the GF, but oil royalties would be switched so that 75 percent would pay for dividends and about 25 percent would go into the Permanent Fund principal. The Permanent Fund would spin off five percent of the fund’s average worth over a five-year period. SB 114 also has a provision that allows the Legislature to appropriate funds into the dividend account if dividends fall below $1,000. Eventually it would be a $1,000 cap on dividends.

McGuire’s plan keeps dividends a bit higher than Walker’s plan would, but it also spins off less money from the Permanent Fund to the GF than the governor’s plan would – it would be a number more like $2.5 billion. SB 114 wouldn’t close the gap, but it would significantly narrow it and stretch out the state’s savings longer, giving the Legislature more time to figure out how to raise the additional revenue.

SB 114 has slowly gained traction with some legislators, but it still carries the weight of reducing individual dividends.

In the end, the state is not broke. As Gov. Walker likes to say, we just have a cash flow problem. But, of course, it’s more complicated than that. Alaskans are protective of their dividends, and many Alaskans, particularly rural and low-income Alaskans use the dividend as a significant part of their own home budgets. For them the debate is not academic.

Legislators say tough choices need to be made. Time will tell if they’re up to the task.