Groundhog Day in Juneau over Permanent Fund
It’s Groundhog Day for Permanent Fund hearings.
The House Finance Committee took up Gov. Bill Walker’s Alaska Permanent Fund Protection Act for the first time of this session on Feb. 2, but it was far from the first time in the last year legislators have been briefed on it.
The bill is virtually identical to Senate Bill 128, the Permanent Fund bill that same House committee voted down 5-6 last June after it passed the Senate 14-5 with broad support from the overwhelming Republican majority.
By his count, Revenue Commissioner Randy Hoffbeck said there were 63 hearings on Permanent Fund legislation during the 2016 legislative sessions.
“Suffice to say there was a substantial amount of work that went into the plan that passed the Senate,” Hoffbeck said to House Finance members.
Legislators are back to examining how and when they will add supporting government services to the short list of duties the Permanent Fund is employed for that that currently begins and ends with paying dividends.
Fully employing the earning power of the Fund is the single largest step Alaska lawmakers can take to reduce the state’s nearly $3 billion budget deficit.
“As a practical matter there’s no other tool out there that can fill more than about one-third of the existing deficit and use of (Permanent Fund) earnings is capable of filling half or more of the deficit,” Legislative Finance Director David Teal said to the House Finance Committee Feb. 6.
This year the governor’s Fund bills are House Bill 61 and Senate Bill 26.
How the bill works
HB 61 would establish an annual draw from the Permanent Fund’s Earnings Reserve account based on 5.25 percent of the Fund’s total market value, or POMV. That annual draw would start pulling approximately $2.5 billion from the Earnings Reserve to close the deficit and pay part of a reformulated dividend.
As of Dec. 31, the Permanent Fund held $55.4 billion in total assets, about $10.3 billion of which was in the Earnings Reserve.
Lawmakers are constitutionally prohibited from spending the $45.1 billion in the principal of the Fund, but the earnings can be appropriated for any purpose by a simple majority; historically, that’s been for dividends only.
While the name may not change, the Walker administration is proposing to change the Permanent Fund Dividend to a Permanent Fund-resource royalty dividend paid from 20 percent of the yearly POMV draw and 20 percent of annual available mineral royalty payments.
Because 25 percent of state resource royalties is constitutionally mandated to be invested in the Permanent Fund, the 20 percent of available royalties equates to 15 percent of overall royalty revenue.
Similarly, 20 percent of a 5.25 POMV draw is ostensibly its own 1.05 percent dividend-dedicated POMV appropriation within the annual draw.
Walker has said he supports tying at least part of the dividend to royalties to better connect it to the state’s fiscal situation.
That formula would mean dividends of about $1,000 per year into the foreseeable future; however, the bill would set $1,000 dividends for the first two years after it was enacted.
The longstanding PFD formula is half of a five-year rolling average of the Fund’s annual investment income.
Hoffbeck and others in the administration acknowledge a 5.25 POMV draw is at the top end of what is sustainable, but say it is necessary given the state is upside down on its 2018 fiscal year budget by more than 260 percent based on current spending and revenue projections.
“We want to be able to extract as much revenue from the Permanent Fund without drawing down so much that we risk the corpus of the Fund,” Hoffbeck said.
“Leaving money on the table” limits the effectiveness of other deficit reduction methods, he added.
A 5.25 POMV Permanent Fund draw minus the dividend appropriation provides nearly $2 billion to close the deficit expected to be about $2.8 billion at the end of the current 2017 fiscal year on June 30.
The administration is also pushing for an immediate effective date on the bill, so if it passes the first draw could be made in fiscal year 2017; it is a way to keep as much money in the Constitutional Budget Reserve, or CBR, as possible.
The state should have about $4.4 billion left in its savings accounts, nearly all in the CBR, at the start of fiscal 2018, according to Hoffbeck.
How much to draw?
Teal told House Finance that — within reason — the exact POMV draw rate is less important than it is often made out to be.
A lower rate means less deficit-filling funds now in exchange for a slightly faster growing Fund over the long-term, he said.
“Just pick something; anywhere between 5.25 and 4.25 (percent) works. What you’re really doing here is trying to find a balance between a high payout and a safe payout,” Teal said to the committee. “Your rate here is important but 4.5, 4.75, 5, 5.25, it’s just a balance that you can argue about but it won’t make or break a plan.”
To that end, HB 61 includes a provision to review the POMV rate every three years to ensure sustainability of the Fund. Hoffbeck said the three-year review was chosen to give each gubernatorial administration at minimum one review.
Additionally, the POMV draw would be calculated based on the Fund’s average value over the first five of the previous six years, which provides several benefits.
First, it helps the Alaska Permanent Fund Corp. know how much cash it needs to have liquid and available for appropriation well in advance of the draw, according to CEO Angela Rodell.
It also gives the state more budgeting certainty and, as long as the Fund continues to grow, should lower a 5.25 POMV draw to something less than 5 percent in real dollars because it is based in part on 5.25 percent of a smaller-than-current Fund, Hoffbeck noted.
The entirety of the proposal is based on the Permanent Fund Corp. being able to maintain its historical average annual Fund return of 6.9 percent.
A single poor financial market year would challenge the budget balance, but shouldn’t wreck the system, Hoffbeck said, emphasizing that a string of poor years is highly unlikely and beyond the state’s ability to counteract.
“We can’t guard against three or four years of catastrophic returns in any (Fund) plan,” he said.
HB 61 also does not explicitly guard against inflation, but rather relies on investment growth to backfill the principal in what Hoffbeck describes as a “feedback loop.”
Excess earnings would be injected into the corpus of the Fund once the Earnings Reserve account is four times the latest POMV draw. The system provides a cushion that allows for annual draws in the event of successive years with poor investment returns, according to Hoffbeck.
While domestic inflation has been very low in recent years, Rodell has said current royalty revenues dedicated to the Fund — roughly between $300 million and $400 million per year — are not sufficient to offset long-term inflation usually assumed to be slightly more than 2 percent annually.
The earnings reserve balance of $10.3 billion puts it in the ballpark of meeting the “feedback loop” threshold currently; depending on what the final POMV rate would be if the bill passed.
Limits on the draw
Finally, the bill has a provision to cap the POMV draw when combined unrestricted resource royalty and production tax revenues exceed $1.2 billion per year.
The annual draw amount available for government spending, excluding the dividend appropriation, would also be reduced equal to royalty and production taxes in excess of $1.2 billion.
Hoffbeck called the spending limit “elegant” and the legislative “hearing process at its best,” noting it was added as an amendment to last year’s version of the Permanent Fund Protection Act in the Senate State Affairs Committee.
The $1.2 billion limit would be activated at oil prices of about $70 per barrel with current oil production levels.
Not only would the cap be a check on government spending, but it would also help grow the Fund in concert with the feedback loop if both mechanisms kick in.
“As this draw would shrink as oil prices rise your Earnings Reserve would grow faster and you’d hit that feedback loop quicker, feeding more money back into the corpus of the Fund and of course as the corpus of the Fund grows, your 5.25 percent draw increases,” Hoffbeck said.
Rep. Les Gara, D-Anchorage, expressed concerns regarding the spending limit, contending it ignores the need to address issues the state has set aside while trying to manage the budget deficit.
“If we ever get to $70 a barrel again, that’s when we don’t get to use the extra state revenue and I think that makes us pretend we don’t have a billion dollar deferred maintenance obligation; makes us pretend that we’re not $30 million behind in school funding from where we were just two years ago,” Gara said.
Stedman’s SB 21
Not to be confused with the state’s ever-contentious oil and gas production tax system best known by its legislative name, Senate Bill 21, Sen. Bert Stedman’s SB 21 would “guard and grow” the Permanent Fund, he said during a Senate State Affairs hearing.
Also a POMV approach, Stedman’s proposal juxtaposes the Walker administration’s bill in its simplicity.
Stedman, a Southeast Republican, is proposing an annual 4.5 POMV payout split equally for government and dividends with few other intricacies.
He told Senate State Affairs that he approached the issue of using the Permanent Fund to help pay for government services by first identifying a structure that would protect the Fund, and then splitting the resulting money 50-50.
SB 21 would set a minimum 2.25 POMV dividend payout first, and a maximum 2.25 POMV for government spending, meaning the government allocation could be used to increase dividends or be reinvested in the Fund if legislators so choose.
The cumulative fiscal year 2018 payout would be nearly $2.2 billion and grow to $2.5 billion by 2022 if historical return averages hold.
The 2018 dividend under Stedman’s formula would be $1,700 per Alaskan.
While a 2.25 POMV-calculated dividend is unlikely to exceed the $2,000 mark as the current dividend formula provided in 2015 and would have in 2016 had Walker not vetoed half of it, it would in essence set a higher dividend floor than the current formula because it would be based on the overall value of the massive Fund instead of a portion of its investment returns.
However, with less than $1.1 billion available for government services, Stedman’s plan would leave a significantly larger budget deficit than the Walker administration’s proposal.
Stedman voted in favor of the administration’s Permanent Fund Protection Act when it passed the Senate last year.
SB 21 does not include a mechanism to inflation-proof the Fund because the spread between the 4.5 POMV and the 6.9 percent average return the Alaska Permanent Fund Corp. has historically achieved would protect the Fund’s real value, he said.
In his committee testimony on his SB 21, Stedman repeatedly referenced a worry that legislators will begin “ad hoc” spending of Fund earnings once the state’s traditional Statutory and Constitutional Budget Reserve savings accounts are exhausted, which is expected to happen early in fiscal year 2019 if a major new revenue plan is not enacted before then.
Walker, many legislators and others in-the-know have warned that spending Permanent Fund earnings absent a sustainable structure to do so would almost inevitably lead to depleting the Earnings Reserve, the eventual end of dividends and the degradation of the Fund’s real value.
“If we want to make sure we have a long-term asset for our children, frankly we have to protect it from ourselves,” Stedman told his fellow legislators.
In 2015, there was talk among Republican leaders in the Legislature about accessing the cash in the Earnings Reserve with a simple majority vote to avoid a budget compromise with House minority Democrats, but it never materialized as a deal was eventually reached.
Fund returned 4.5% in first half of FY17
The Alaska Permanent Fund Corp. managed a 4.5 percent return out of its namesake fund in the first half of the 2017 state fiscal year, according to a Feb. 7 corporation release.
As of Dec. 31, the Fund had a total value of $55.4 billion with $10.3 billion in the Earnings Reserve. It had grown to $56.1 billion by Jan. 30, according to the APFC’s unaudited monthly report.
The Fund ended the 2016 fiscal year with a total value of $52.8 billion.
The 4.5 percent six-month return outpaced the corporation’s passive investment benchmark by 2.5 percent, CEO Angela Rodell said in the release.
Over the past five years the APFC has achieved an 8.36 percent return.
Positive returns were led by a 7.61 percent return in the Fund’s stock portfolio, a reflection of “strength in the U.S. stock market that marked returns in excess of 10 percent,” the release states.
However, rising interest rates correlated into a negative-2.37 percent return on bonds, according to the corporation.
Traditional stocks and bonds combine to account for nearly two-thirds of the Fund’s overall investment allocations.
Elwood Brehmer can be reached at [email protected].