Administration will introduce bill to convert Fund earnings
The slide in crude oil prices is continuing, and transforming Alaska’s state finances to revenue sources more predictable and sustainable than oil income has taken on more urgency.
Year-to-date prices for North Slope crude oil were at an average of $49.98 per barrel as of Nov. 17. That’s since July 1, the start the current fiscal year, and it is $16 per barrel less than the price of $66.03 per barrel predicted by the state last March and used as the basis for budget planning.
Year-over-year production numbers are better, with an increase of about 3.7 percent since the start of the fiscal year through Nov. 15. Daily production in November is averaging about 555,000 barrels per day compared to about 537,000 barrels per day in November 2014.
How much the price shortfall will balloon the state budget deficit is uncertain, but a deficit well greater than $3 billion is certain.
Is there a better way? State officials have been quietly working since last January on a plan to transform Alaska’s fiscal system and some concepts have been rolled out in recent weeks before legislative and business leaders.
State Attorney General Craig Richards surfaced the concept, still a work-in-progress, in a recent briefing to state legislators and, more recently, to the Alaska business policy group Commonwealth North.
The plan, being labeled a “sovereign wealth” fund, would replace oil revenues with earnings from the $53 billion Alaska Permanent Fund. Richards warned, however, that the idea if implemented next year would still leave an estimated $1 billion gap that would require new revenues, most likely new taxes.
A preliminary estimate for the idea allows for about $3.1 billion per year to be paid to the general fund from Alaska Permanent Fund earnings, and have about $1 billion paid additionally from other state taxes, for a total of $4.1 billion.
This assumes a status-quo state budget of about $5.1 billion in unrestricted general fund spending, leaving the $1 billion remaining gap. However, legislators are likely to reduce the budget to less than $5.1 billion next year.
Legislators were briefed on the idea in Juneau during the recently-concluded special session of the Legislature, which had been called to consider Gov. Bill Walker’s idea to buy TransCanada Corp.’s share of the Alaska LNG Project, which lawmakers approved.
Members of the administration’s working group have not been identified except that it includes economists from the Department of Revenue and other state agency officials as well as Richards. The administration officials confirmed that there will be a bill introduced for the 2016 session outlining the plan.
The concept basically involves bulking up the Permanent Fund by diverting some oil revenues to the Fund that now go to the state general fund.
Income earned by the Fund would flow into its Earnings Reserve Account, as it now does. Currently there is about $9 billion in the earnings account.
Withdrawals would be made annually from the earnings account by the Legislature to support the state budget, using some as-yet-undetermined formula.
The state constitution prohibits spending money from the principal of the Permanent Fund but income that has accumulated in the Earnings Reserve can be appropriated by the Legislature.
An important change in the plan is that it would indirectly reduce the amount of money available for the Permanent Fund dividend. If the plan were in place next year the 2016 dividend would be $1,000, about half the 2015 amount, Richards told the legislators.
The effect of that would be, indirectly, to put more money into the Permanent Fund, creating more earnings that would support the state budget.
John Tichotsky, chief economist in the state Department of Revenue, told members of Commonwealth North’s fiscal task force recently that a major goal of the plan is to take the volatility of oil revenues out of the state general fund, which is now 90 percent dependent on oil, and place it into the Permanent Fund, which can smooth out the volatility because of its sheer size.
There would also be a more stable source of revenues for the state general fund.
Other key goals include keeping the Permanent Fund on a sustainable basis in terms of its real, or inflation-proofed, value, Tichotsky told the Commonwealth North group.
Legislators have voiced few opinions about the plan but some who did speak were cautious. Sen. John Coghill, R-Fairbanks, who is Senate Majority Leader, attended the Juneau briefing and complimented the governor for stepping forward with a plan, but had some mixed views.
“I think it’s complicated. It doesn’t really bring in more money, but just rearranges the plumbing,” he said.
Coghill’s point was that the same goals can be accomplished in simpler ways that would be more understandable by the public, and possibly more transparent.
For example, just appropriating a portion of the Fund’s annual earnings and capping the dividend might achieve the same results.
Others who have looked at the concept are intrigued, however. Cheryl Frasca, a former state budget director who chairs Commonwealth North’s fiscal policy task force, is open to the new ideas.
“I think it’s an interesting approach for a couple of reasons,” she said.
One is the proposal, in the plan, to fund the annual citizen dividend with a percentage of oil royalties rather than earnings from the Permanent Fund, as happens now.
“It ties a ‘royalty dividend’ (now the Permanent Fund dividend) directly to oil and gas development instead of Wall Street investment returns,” the current system, she said. “That changes the dynamic of support and creates a constituency that supports future oil and gas development. After all, it’s claimed that it’s ‘our oil.’”
A second interesting point, she said, is that it would require a limit on the amount of revenue taken annually from the earnings account, although the mechanism for that is still being developed.
“This could be a good tool to control spending. I believe Anchorage’s municipal tax cap (a somewhat similar mechanism) is a very efficient tool that has limited Anchorage’s spending swings over the years,” Frasca said. “This means that if the Legislature wants more money it will have to go to other tax sources,” which will encounter resistance.
“Other taxes become the wild card in terms of generating additional revenues to support increased spending. Lots of constituencies protecting sources for these revenues, so it creates a counter-balance against increasing spending,” Frasca said.
In a recent talk before the Alaska Miners Association’s annual convention, Northrim BanCorp CEO Joe Beedle said he likes overall concept the Walker administration is advancing.
“Whether it’s called an endowment, a sovereign wealth fund or Permanent Fund, I believe the concept is very good,” Beedle said.
He also liked the direct connection between the dividend and state oil and gas income, he said.
There are other views on that, however. Some see a severing of the connection between the Permanent Fund and the dividends having the effect of reducing citizens’ interest in the Fund and their role as watchdogs on any imprudent investments or a Legislature’s way to “raid” the fund indirectly by using it as loan collateral, which can be done.
Linking the dividend to the Permanent Fund performance was central to the idea of the dividend advanced in 1980 by former Gov. Jay Hammond, who saw it as a way of developing safeguards for the Fund.
There are also many features of Walker’s fiscal plan that are not yet developed, however, and details are important.
Tichotsky, of the Department of Revenue, told Commonwealth’s fiscal task force that a crucial decision yet to be made is whether to use some form of Percent-of-Market-Value, or POMV, formula to annually draw funds for the budget or to develop a fixed yearly payment, perhaps inflation-adjusted.
The Percent-of-Market-Value payout method is commonly used by large endowments like those held by universities and large charitable funds. It makes a payment based on the overall market value of the endowment. The payment is typically less than the projected average total earnings, such as a 4 percent payment from earnings averaging 8 percent, with the remaining 4 percent of earnings are retained to adjust for inflation.
One problem with the POMV is that, assuming a steady growth of market value, it would tend to automatically increase the amount of revenue available to the Legislature, which would inevitably lead to greater spending.
One advantage of the fixed-draw is that this would be a true cap on spending, although there would have to be periodic “reopeners” of the cap to make adjustments, such as for inflation or population growth.
Eric Wohforth, co-chair with Frasca of the Commonwealth North task force, said he is concerned about a fixed-draw because any necessary adjustment mechanisms would be complex, difficult for the public and inevitably less transparent.
“There’s total transparency to percent-of-market value. Everyone can see what the market value is, so it’s very simple,” Wohlforth said.
Wohlforth is an Anchorage attorney and a former Permanent Fund trustee and state Revenue commissioner.