Dear Friends and Neighbors,

Now that the House and Senate have both passed an operating budget, the next question is “How do we fund state government?” We did not look at cost savings and revenue generation at the same time, which means we have a lot of work to do with only 30 days left in the session. West Anchorage constituents have told me that we can’t kick the can down the road and hope that the price of oil goes up. We need a responsible action plan for Alaska—and we need it this year.

Status of the Budget Process

At this point in the session, the House and Senate have both passed operating budgets on party-line votes. The Governor began the process with about $100 million worth of cost savings to the State’s budget. The House cut approximately $288 million from the State’s operating budget. The Senate budget cuts a total of approximately $351 million from the operating budget. With an operating budget of approximately $3.8 billion, the proposed cuts confirm what economists have been explaining for months: we cannot solve are fiscal challenge by budget cuts alone. For example, the $351 million budget cut proposed by the Senate is approximately a 9% budget cut. Interestingly, Senate leadership recently suggested that it would not approve any of Governor Walker’s proposed revenue measures and would, instead, use savings to pay for state government.

In deciding whether we have a responsible action plan for Alaska, I believe we should consider five factors:

• Does it make substantial progress on closing the $3.8 billion deficit?
• Does it drive our economy into a deep recession or does it support a strong economy?
• Will Alaskans have an opportunity to weigh in on the proposal?
• Does it protect the Permanent Fund for future generations?

Economists like ISER’s Gunnar Knapp have consistently shown that a responsible action plan for Alaska will include restructuring the Permanent Fund. In response, the Walker-Mallott administration and legislators have introduced three different proposals for Permanent Fund restructuring.

Permanent Fund Restructuring Models: Status Quo, PFPA, SB 114/HB 303, HB 224

Three separate bills have been proposed to restructure the Permanent Fund and State cash flow. While this newsletter is longer than usual, I am committed to keeping you as informed as possible. So I’ll take you through those three proposals. Last month the Director of Legislative Finance presented on all three Permanent Fund restructuring plans. You can watch that entire presentation here.  

Status Quo

First, the current cash flow plan. As shown in the graphic below, the oil royalties (e.g. an ownership of future production and is a typical feature in oil and gas contracts) are distributed into the Permanent Fund Principal (30%), the Public School Trust Fund (0.5%), and the General Fund (69.5%). At this time, royalties (69.5%), production taxes, and other “less volatile” revenue sources, like alcohol and tobacco taxes, are put into the General Fund to fund state services. The projected $3.8 billion deficit is because these sources to the General Fund are not sufficient to pay for the cost of government.

The Permanent Fund dividend is calculated using a formula based on 21% of 50% of the five year earnings of the Permanent Fund Earnings Reserve account. The Earnings Reserve Account is made up of the investment earnings from the Permanent Fund principal. The Alaska Constitution does not allow the Legislature to spend from the Permanent Fund principal, but the Legislature may spend from the Earnings Reserve Account (ERA) by majority vote.

If we do no not restructure state revenue and spending this year, we will have to use savings from either the ERA (approximately $8 billion currently) or the Constitutional Budget Reserve (CBR) (approximately $8 billion) to fill the deficit. If we use CBR saving first, that savings would run out in 2-3 years. In the same way, using the Earnings Reserve to pay for state government without restructuring the Permanent Fund will drain the fund of all savings and eliminate the dividend altogether.

This scenario describes the state’s current cash flow structure. The three proposals to restructure the state’s cash flow address different ways to reduce the deficit by using the Earnings Reserve Account (not the Principal) to support state government. All three proposals reduce the dividend and protect the Permanent Fund for many years to come.

Permanent Fund Protection Act (PFPA)

The Permanent Fund Protection Act (PFPA) is the Walker-Mallott proposal to reduce the State’s reliance on the volatilities of the oil market and plan for the future. The plan includes several changes to the status quo:

• Changes the royalty percentages deposited in different funds
• Re-routes production taxes and royalties (74.5%) to the Earnings Reserve Account—not to the General Fund
• Adds an annual draw (approximately $3.3 billion) from the ERA to fund state government
• Removes the inflation proofing component that transfers money from the ERA to the Principal
• Calculates the Dividend based on 50% of the previous year’s total royalties

Governor Walker based this plan on an endowment-like model. It relies on the earnings from Permanent Fund investments growing to a level at which Alaska’s investment earnings are sufficient to be the major source of funding for the state government as oil revenue declines. It reduces the State’s reliance on the volatilities of the oil market and the need to use large amounts of savings each year from the CBR or the ERA to balance the budget. And by making the changes this year, the Walker-Mallott plan protects the Permanent Fund Dividend for future generations.

Senate Bill 114/House Bill 303

This bill (the same bill is introduced separately in the House and Senate) focuses on restructuring the Permanent Fund. Like the PFPA, SB 114/HB 303 makes significant changes to the State’s cash flow structure:

• Draws 4.5 % of the total market value of the Permanent Fund (Principal + ERA) to the General Fund
• If the value of the ERA is more than 4 times the maximum draw allowed (4.5% of the total market value), the excess in the ERA can be transferred into the Principal of the Permanent Fund
• Calculates the Dividend based on a percentage from royalties, a percentage from the 5 year average earnings, and a percentage of the CBR balance with a $1000 dividend floor
• Allows the Revenue Commissioner to review the dividend calculation with the Permanent Fund Corporation and change the dividend calculation

Like Governor Walker’s plan, SB 114/HB 303 relies on the earnings from Permanent Fund investments growing to a level at which Alaska’s investment earnings are sufficient to be the major source of funding for the state government as oil revenue declines. It recognizes that the CBR and the ERA are not sufficient to fund state government in the long term given declining oil production. And by making the changes this year, businesses that have analyzed SB 114/HB 303 find that it can protect the Permanent Fund for future generations.

House Bill 224

House Bill 224 is commonly referred to as the percentage of market value (“POMV”) model. The model makes 4.5% of the total market value of the Permanent Fund (Principal + ERA) available each year for appropriation from the ERA to support state government. Like the other two restructuring plans, House Bill 224 makes several changes to the State’s current cash flow structure:

• Distributes 4.5% of the total market value of the Permanent Fund (Principal + ERA) from the ERA to a Distribution Account for potential transfer into the General Fund
• 100% of the payout to the distribution account is available for transfer to the General Fund
• After filling any remaining budget deficit, HB 224 proposes variable dividends based on savings balances
• After paying dividends, leftover funds replenish the CBR for prior expenditures
• Dividends in the future are not assured

Unlike the other two proposals, HB 224 does not deposit any future royalties or production taxes into the Principal. It relies on Alaska’s investment earnings providing a the major source of funding for the state government as oil revenue declines. And its goal is to protect the Permanent Fund for future generations, but not necessarily the dividend.

The Legislature continues to review all three proposals. We welcome your ideas and opinions on these three plans or any other issue. In our community survey this year, 72% of West Anchorage respondents supported changing the Permanent Fund in some way. Alaska is looking at major deficits this year, and we cannot balance the budget with cost savings alone—today and in the future. Changing the structure of State cash flows is a critical component to any responsible action plan for Alaska.

Early voting for the Municipal Elections begins March 21st! Click here for more information about where and how to vote!

As always, please let us know if you have other suggestions or concerns.

Sincerely,

    Rep. Matt Claman

    P.S. follow me on Facebook and Twitter

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