Teal: The Color of Scary Math

Teal delivers overview of proposed '17 budget

Medium Grind -- News and Analysis

This week Legislative Finance Director David Teal delivered his annual high-level overview of the governor’s budget to the House and Senate Finance Committees. Teal has been director since 1998. His soft-spoken, steady presentation style is legendary. Teal works for the legislature, and answers to majority leadership. His delivery has long been crafted to deliver bad news in the gentlest possible way to the people who butter his bread. The past two years have seen a shift in Teal’s demeanor, however. He’ll never be a firebrand, but he’s delivered the harsh reality with more blunt force.

Even bluntness doesn’t always work. During a presentation to Senate Finance last year, after the committee had slashed the operating budget down to the bone, one senator asked Teal how much more he thought they could cut in 2016. Teal paused and then in his steady Mr.-Rogers-like manner said something like, “I’m frankly surprised you were able to cut as much as you did this year.” It was meant, I think, as a word of caution. It was taken instead as a compliment. This year Teal continues his attempts to convince legislators that cutting simply isn’t going to get it done and it may, in fact, make things worse.

Teal’s presentation is intended to review the governor’s proposed budget, but it was a more difficult task than usual this year. Of course it’s hard to describe a budget that starts $3.6 billion in the hole, but complicating things further Gov. Bill Walker transmitted a budget based on the hope that the legislature will pass all of the bills in Walker’s fiscal plan. It’s a budget that could be, but only if dramatic policy changes are enacted this session. As mentioned in previous Grinder News posts, Walker’s proposals include a complete re-plumbing of the state’s cash flow (adding Permanent Fund earnings to the revenue mix for the first time) a suite of taxes and a significant change in the way Permanent Fund Dividends are paid. If those changes, or some others are not made, the budget is back in a multi-billion dollar hole.

Another point worth noting before diving in is the governor’s budget is based on a Department of Revenue forecast for an average oil price for 2016 of $56 per barrel. You might have noticed oil is more like $26/bbl now, and hasn’t been $56/bbl since Rep. Bob Lynn guided his Sopwith Camel above the Kaiser’s hoards. So, the bad news is things may be worse than they seem on spreadsheets; the good news (if you want to call it that) is, based on the structure of the current oil tax regime Alaska only earns a couple hundred million more dollars at $56/bbl than it does at $30/bbl. It’s a sad excuse for a silver lining, but you take what relief you can get in a hurricane.

Teal opened with a critical question: Do you perceive the cause of the problem as rising expenditures or as falling revenues?

When you’re facing a massive shortfall that question may seem moot, but the answer goes a long way toward determining how you tackle the challenge. The graph below, from Teal’s presentation, should be instructive in answering the question.

The green landscape in the above graph represents annual state revenue beginning in 1975. It peaks in the early ‘80s when both oil price and production were strong, and then it drops in a way that reflects a price crash and both declining production and the original tax system that reduced oil tax rates as fields matured. Revenue didn’t start picking up again until Gov. Frank Murkowski’s PPT oil tax reform and then much more dramatically after Gov. Sarah Palin’s ACES oil tax reform that passed just in time to capture massive windfalls from a dramatic and unexpected price spike.

The popular myth is that government spending blew up whenever revenues increased. As you can see in the chart, that’s only partially true, and most of the large spending increases came on the capital side. Grinder News added the red line to Teal’s graph at the proposed level of agency operating for Walker’s 2017 budget. Tracing that line back through the purple agency operations bars a couple things become clear. Going all the way back to about 1986 the legislature has actually held a responsible and pretty steady line on operating spending. This graph is adjusted for population growth and inflation, so the agency operations bar is indicative of how much the government has spent per Alaskan in adjusted dollars. Alaska is spending more per Alaskan in nominal dollars today than it did in ’86, and there are a lot more Alaskans now than there were 30 years ago, but a 2016 dollar is worth about thirty-three cents in ’86 so, as you can see, operations spending is actually down.

This slide didn’t sit will with North Pole Republican Rep. Tammie Wilson. She took Teal to task for including inflation in the calculation.

“Inflation’s kinda, I know there’s some kind of mathematician who believes in that,” Wilson said, “but I think for mine it would be easier to explain how the population growth, and how much operations have gone, and the comparison without having in there the CPI. I just think the graph would look a lot different.”

No doubt the graph would look different, but inflation is kind of like gravity. It pulls you down whether you believe in it or not. It might be politically easier to explain spending without inflation, but it’s not accurate. A twenty-six-year-old professional today might be earning $70,000 per year. Her father earned $35,000 when he was 26 back in the ‘80s. He might say, “What’s wrong with you? You should have twice the house I had but you’re living in a two-bedroom apartment.” Her problem is that her $70K salary today would have been worth less than $24K back in ’86. If you don’t believe it, just have coffee with a Milllennial ... you’re buying. Teal explained that population growth alone is responsible for about two-fifths of the growth, so inflation actually gets the lion’s share. The important point is that on a per-capita basis Alaska’s agency operations are actually less now than they were thirty years ago, and less than they were during the recent revenue glut. Overall operating budgets have remained largely flat for decades.

There is another telling story in the graph. The yellow segments of the bars represent capital spending. It tends to grow much more rapidly than operating spending during high revenue years. However, if you look at the 2016 budget, capital spending dropped to almost zero. The upshot was that drop represented most of the massive cuts the administration and Legislature made last year, and that kept the department cuts a little less painful than they might have been. Unfortunately, you can only cut capital spending to zero once. To make this year’s reductions similar to last year’s would mean everything has to come from operations, and Teal said repeatedly he just doesn’t see where that kind of money is available in department budgets.

Will the Dinosaurs Save Us Again?

Alaska’s been down before. I first arrived here in 1986 as a bright-eyed airman at Elmendorf AFB. I had no idea that I’d walked into an economic sinkhole, but it didn’t take long to figure it out. Anchorage was dotted with brand new cookie cutter strip malls, each with a blue metal roof. Almost all of them sat empty with signs offering to practically give away space. The story of people just dropping keys on kitchen counters and walking away are ubiquitous in recollections of the crash. My little family, collecting a housing allowance and cost of living allowance still based on a pre-crash economy were able to rent a beautiful custom home in Chugiak for pennies on the dollar. To many it seemed the good times were over.

But the dinosaurs in the ground wouldn’t be slayed so easy, and in the volatile world of big oil, dreams can be as common as nightmares. Prices picked back up, and the economy got well. Candy bouquet, and pedicure shops moved into strip malls and all was right with the world.

It happened again after a downturn in ’99, and then, thanks almost entirely to dumb luck the state took a money bath between about 2006 through 2012. The dinosaurs weren’t stampeding down the TAPS line like in halcyon days, but the market made each one of them more valuable than ever before, and ACES, not really meaning to, cashed in on it. It’s a good thing it did, or you and I would be jockeying for position on refugee rafts today instead of debating a budget shortfall.

The truth is nobody knows if or when oil will bounce back again, but a lot of factors suggest the dinosaurs simply won’t save us this time in any case. For one thing, if the current oil tax regime isn’t changed the state doesn’t see real money from oil until it’s at about $80/bbl. It has not been at that price very often, or for very long, in the past, and the world is changing, reducing it’s demand for crude. More importantly for Alaska, production continues to decline. The current tax system, Gov. Sean Parnell’s SB 21 was supposedly designed to entice investment in exploration and technology to spur increased production.

You could argue whether or not that was a wise model, but it’s irrelevant at this point. No amount of enticement will encourage investment in Alaska’s oil fields when oil is cheaper than the barrels it’s shipped in. And, with the current model, oil would have to be at $113/bbl to balance Alaska’s budget (considering some factors not in Teal’s graph you could argue $104/bbl, but again, that number is just too high). Even under ACES it would have to be somewhere north of $80/bbl. Here’s another slide from Teal’s presentation.

The graph above makes several key points. Unlike some of Teal’s other graphs this one looks at current world only, rather than at what the world would look like with Gov. Walker’s new fiscal plan.

First notice the break-even point, where the budget balances, at $113 per barrel oil.  The blue landscape in the background shows how much the state earns for oil at different prices.

Moving down the slope left from the breakeven point the next stop is where the Department of Revenue forecasted the average price of oil to be for 2016. At the far left the graph stops at $30/bbl. Oil is actually at $26 today, so Teal’s Alaskan optimism may have gotten the best of him.

So the first big takeaway is that oil will have to reach a price no one expects for a long time, if ever, before we can stop borrowing from our savings. The second important point can be found on the blue landscape. On the left half of the scale the slope is gradual, meaning changes between say $30/bbl and $50/bbl don’t actually represent much of an increase in state revenue. The slope doesn’t start climbing in a meaningful way until about $80/bbl where the minimum tax gives way to the base rate. In future years that’s complicated further by certain credits and deductions and the definition of “new oil,” but that’s for another article.

This graph is a good depiction of why the dinosaurs aren’t going to save us.

Panic Button: Now or Later?

Oil isn’t going to save us, and the deficit is so much bigger than government you could cut government to the marrow and not make a scratch in the deficit’s paint job. Legislators know it’s going to take some new approach to revenue to solve the problem, but it’s an election year, and it’s really hard to think of a nice way to say “tax” or “Permanent Fund draw.” Everybody says now is the time for leadership, but most would prefer it if someone else took the wheel.

Bearing that in mind one question came up several times during Teal’s presentation. “So, uh, if we don’t do anything, how long before we’re actually like, out of money?” Teal could only think of so many ways to say, “Four years.” It’s true. With a little less than $7 billion in the Constitutional Budget Reserve, and about the same amount in the Permanent Fund Earnings Reserve the state has just under $14 billion in the piggy bank. At $3.6 billion, the shortfall gobbles that up in a little less than four years. Even if you closed the government with cuts ... four years.

That means after 2020 the legislature will be forced to add all Permanent Fund earnings to its revenue stream. That will mean a shrinking government ... it will also mean no more dividends ... ever.

That’s the cost of kicking this particular can down the road. Some legislators will continue to tell us they’ll fight to protect our dividends from government, but they can’t. Anchorage Democrats Rep. Les Gara and Sen. Bill Wielechowski have said they want to enshrine the dividend in the Constitution. They have also both said they don’t want to lay off teachers or close schools. In the new Alaska we simply can’t do both. Alaskans at some point in the near future will have to decide whether they want big PFDs for four years and severely-diminished government services forever or if they’d prefer smaller PFDs and less draconian cuts to government. It’s the fundamental question that has to be answered before the savings run out.

In another exchange with Teal Rep. Wilson said she’d like to know who is paying for government and who is using the services. She said it seems a small group of people use most of the resources while a large group pays for most of them. In her own case, she said, her own kids are no longer in school, so her North Pole property taxes get her little more than a place to take her trash.

In a futile effort Teal offered a few philosophical nuggets pointing out that some people think someone had paid for Wilson to go to school, so now she’s taking care of the next generation. He pointed out that the “right size of government” isn’t something you get from a calculator or spreadsheet. “The right size of government depends on you.” It depends on a philosophical compromise between 60 people sent to Juneau – 60 people with myriad ideologies and philosophical notions about the relationship of government to the people it serves. That’s why it’s going to take at least 90 days to get anywhere.

But again, the answer to that question isn’t going to help legislators navigate their way to either a fiscal solution or to reelection. The fact that anyone is still pondering questions like that suggests that they’re tone deaf to Teal’s repeated admonishment that “you just can’t cut your way out of this.”

Teal's slide below provides an interesting illustration of the problem.

The above Legislative Finance graph shows that the state’s estimated 2017 revenue of $1.8 billion will cover the operation of 17 government departments. The combination of the Department of Health and Social Services, Department of Education and Early Development and statewide operations adds up to the $3.7 billion deficit. You can’t do much with statewide because most of it is related to debt reimbursement and retirement obligations, two things you can’t do much with.

The point really is there’s very little left to cut from the 17 departments under the revenue umbrella, and trying to cut education and health programs is fraught with political, economic and social peril. If you think legislators don’t like talking about taxes, just try to get one to tell you he wants to shut down your kid’s school.

This is a long piece and a lot to digest. Grinder News is moving its operations to Juneau for the remainder of the session, so we'll be off the grid for a couple days; back online on Monday.