Weathering Alaska's Fiscal Storm: The Challenge & Solution

Weathering Alaska’s Fiscal Storm
The Challenge …
The Solution
STUDENTS WHO ENJOY ECONOMIC THINKING
UNIVERSITY OF ALASKA - FAIRBANKS
OCTOBER 17, 2015
Dr. Scott Goldsmith
Professor Emeritus
UAA & ISER
Brad Keithley
President
Keithley Consulting, LLC

Summary
 The challenge
 Alaska’s current, “business as usual” fiscal model – matching
current spending to current oil revenues – is failing
 Even before the price drop, declining oil production and rising
spending were heading Alaska toward a “fiscal cliff”
 The price drop has brought us face to face with the cliff
 The solution
 A “sustainable budget” model matches spending levels to
long term revenues, avoids a fiscal cliff, achieves
intergenerational equity and provides long term fiscal stability
 The current “sustainable” level is $4.5 billion (down from $6
billion 3 years ago due in part to continued overspending)
 Transitioning to a sustainable model can be done over time,
but the longer the “transition,” the lower the sustainable
number
2

Problem has been building
2013 …
“Right now, the state is on a path
it can’t sustain. … we do not
have enough cash in reserves to
avoid a severe fiscal crunch soon
after 2023, and with that fiscal
crisis will come an economic
crash.” --ISER Web Note 14 (2013)
2014…
“The implications of the figures
are severe … Failure to reduce
the projected deficits will result in
a very hard landing -- Legislative
Finance Division (2014)
3

And then this happened … 4
ANS Price
FY 2014
Actual $108
UGF Pet Rev $4,763 mil
FY 2015
Actual $ 73
DOR est $ 67
FY 2016
Since July $ 51
DOR est $ 66
The future (2023) is now …

What does it mean … 5
$105 $70 oil
• The revenue equivalent of a
54% production decline to
~230,000 b/d
At current spending rates:
• Draining ~$10+ million per day
from savings
• ~$3.8 billion (60+%) deficit
(~$5,250 per Alaska man,
woman and child; $21,000 per
family of 4)
• Less than 3 years of unrestricted
savings (CBR) remaining as of
June 30, 2015
Statutory and Constitutional
Budget Reserves
$-
$1
$2
$3
$4
$5
$6
$7
$8
$9
$10
2016 2017 2018 2019 2020 2021 2022 2023 2024
Billion$
Start of Fiscal Year
CASH RESERVE LIFE
AT DIFFERENT OIL PRICES
$100
$90
$80
$70

What’s ahead …
If we continue to conduct business as
usual …
 Historically Alaska has tied spending to
current revenues creating a boom and
bust cycle dependent on current oil prices
and volumes
 Successfully maintaining that approach is
highly dependent on ever increasing price
and volume
 Recent pricing events demonstrate that is
an ill-founded premise
6

The problem is more than
falling production …
 The “Alaska Disconnect” (from ISER)
 As Alaska’s economy and population grow, demand
increases for services that state and local governments
provide
 Although the new Alaskan businesses and population
pay local sales and property taxes which support local
services, they don’t pay broad-based state taxes to
cover the increased cost of state-funded services
 As a consequence continued economic development
and population growth ironically makes the state’s fiscal
situation worse
 To now, this situation largely has been masked by
high oil production and, until recently, prices
7

If we hit the trifecta … 8
Assumptions …
$105 oil
2% production decline
Viscous oil: 2020
NPRA: 2020
New Conv Oil: 2020
Gas (high price
scenario) 2024
OCS: 2026
ANWR: 2026
$0
$5
$10
$15
2016 2020 2024 2028 2032 2036 2040
UNRESTRICTED GENERAL FUND
(BILLION $)
? PF CORPUS DRAW
? PF INFLATION PROOFING
? PF EARNINGS
? DIVERT PFD TO GF
? INCOME/SALES TAXES
? NATURAL GAS
? NEW OIL
CASH RESERVE
CURRENT OIL REVENUES
NON OIL REVENUES
$0
$5
$10
$15
$20
$25
$30
2016 2020 2024 2028 2032 2036 2040
SBR & CBR
CASH RESERVE (Billion $)

But if we don’t (middle) … 9
Assumptions …
$90 oil
Viscous oil: 2020
NPRA: 2020
New Conv Oil: 2020
Gas (moderate
price scenario) 2024
No near future OCS or
ANWR
$0
$5
$10
$15
2016 2020 2024 2028 2032 2036 2040
(BILLION $)
? PF CORPUS DRAW
? PF EARNINGS
? DIVERT PFD TO GF
? NATURAL GAS
? NEW OIL
CASH RESERVE
NON OIL REVENUES
$0
$2
$4
$6
$8
$10
$12
2016 2020 2024 2028 2032 2036 2040
SBR & CBR

A low case … 10
Assumptions …
$80 oil
Viscous oil: 2020
NPRA: 2020
New Conv Oil: 2020
No near future gas, OCS or
ANWR
$0
$5
$10
$15
2016 2020 2024 2028 2032 2036 2040
(BILLION $)
? PF CORPUS DRAW
? PF EARNINGS
? DIVERT PFD TO GF
? NATURAL GAS
? NEW OIL
CASH RESERVE
NON OIL REVENUES
$0
$2
$4
$6
$8
$10
$12
2016 2020 2024 2028 2032 2036 2040
SBR & CBR

Where does that lead …
“… reducing expenditures
… institution of a broad-
based tax, and use of a
portion of the earnings of
the Permanent Fund ….”
Northern Economics and ISER, Potential
National-Level Benefits of Alaska OCS
Development (2011)
11
Draining the CBR/SBR to maintain current spending
shifts all of the consequences to future
generations—massive cuts and new taxes-- and
creates an uncertain and unstable climate for
future investors

The better alternative …
“I will make the hard choices necessary for a
sounder fiscal future, including putting in place a
sustainable budget. I will work to make sure the
investment climate in Alaska supports those goals,
which includes creating a favorable fiscal climate
for citizens and companies investing in our
economy.”
– Candidate Bill Walker on fiscal responsibility
12

What is a “sustainable”
budget …
 A calculated revenue and
spending level which, if
adopted now, can be
maintained consistently
long into the future,
adjusted for inflation and
population growth
 Based on both current and
projected revenue streams
and asset levels
13

What is the current
sustainable level …
NEST EGG
Nest egg draw $ 5.4 B
PFD payment (1.4)
Net revenues $ 4.0 B
UGF non-petroleum
revenues $ 0.5 B
UGF Sustainable
Revenues $ 4.5 B
SUSTAINABLE UGF REVENUE
Financial Assets $66.2 B
NPV of Future Oil/Gas 68.9*
TOTAL NEST EGG $135.1B
Real rate of return
(5%)minus population
growth (1%) 4%
Nest egg draw
($135.1 x 4%) $ 5.4 B
14
* Based on oil prices projected in DOR Fall 2014 Revenue Sources Book, plus
production assumptions beyond RSB forecast reflected in “middle case” (p. 9).

Sustainable budget …
Results …
 Treats all generations
equitably
 Encourages investment
and growth by providing a
stable, long term fiscal
structure
 Smooths the revenue curve
even during turbulent times
 Encourages and facilitates
state support for resource
development
Requires …
 Fiscal discipline to limit
current spending to
sustainable level (or enact
supplement revenues)
 Treating all current savings
and reserves as long term
investments (“NEST EGG”)
15

Each generation can add
revenues …
Sustainable budgets provide each generation with a base
level of revenue with the flexibility to supplement if desired
16
If desired
spending level
is ($oil/b) …
Sustainable
Revenue
level is …
And required
supplemental
revenue is …
Supplemental
revenue
per Alaskan
$6.0 B ($120) $4.5 B $1.5 B $2,050
$5.5 B ($114) $4.5 B $1.0 B $1,400
$5.0 B ($109) $4.5 B $0.5 B $690
*For reference, 2015 PFD was $2072; average L48 state
sales/income tax level: $1800/resident

The costs of delay …
Spending above sustainable levels offsets the short
term economic impact of current spending
reductions but reduces the nest egg and as a
result, future sustainable revenue levels
17
Costs of delay
MSY
FY 2012: $6.2 B
FY 2013: $6.4 B
FY 2014: $5.5 B
FY 2015: $5.0 B
FY 2016: $4.5 B
$7.0
$7.8
$7.2
$6.2 $5.2$6.2 $6.4
$5.5
$5.0
$4.5
2012 2013 2014 2015 2016
$Billion
Fiscal year
Actual v. Sustainable Spending Levels
(FY 2012 - 2016 (est.))
Actual Spending Sustainable Spending Level

Going forward options &
costs …
Future Sustainable Budget Levels @ Overspend Above $4.5 B
Transition Period $500 M $1 B $1.5 B
1 year $4.47 B $4.45 B $4.43 B
2 years $4.45 B $4.41 B $4.36 B
3 years $4.43 B $4.36 B $4.29 B
4 years $4.40 B $4.31 B $4.22 B
18
A four year transition reduces
the sustainable spending level
between 5 and 10% (e.g.,
overspending $4.5 B by $1.5
B/yr for four years reduces the
sustainable level to $4.22 B)

The FY2016 Budget…
Operating Budget:
Formula: $2.1 B
Non-Formula: $2.0
Debt Repayment: $ .2
O&G Credits $ .5
PERS/TRS $ .3
Total (rounding) $5.1 B
Capital budget: $ .1
Total $5.2 B
19
FY 2016 Unrestricted General Fund (UGF) Budget
FY 2016 ($5.2 B) – Sustainable Budget ($4.5 B) =
$700 Million overspend

Making FY 2017 budget
more sustainable …
 Capital Budget is already
minimal
 Attention will need to turn to
the big drivers in the
Operating Budget (FY2016):
 DEED/ K-12 ($1.3 B)
 DHSS/Medicaid ($1.2 B)
 O&G tax credits ($.50 B)
 University ($.35 B)
 Corrections ($.28 B)
 Personnel count and cost
20
Or, supplement revenue to avoid
impact of overspend on future
generations

A Comment on Potential
New Revenue Sources
 Sustainable budget already incorporates income from
Permanent Fund not used for PFD & inflation proofing
 Material new revenue sources
 PFD cap (incorporating remainder into UGF)
 Broad based taxes (state sales and income)
 Issues
 Significant regional and socio-economic disparities
 Effect on local government, private sector and Alaska’s
competitiveness
21

Other Suggested Solutions
 Squeeze oil harder
 Manage Permanent Fund like a Hedge Fund
 Tax other Natural Resources
 Tax SIN
 Economic Diversification
 Value Added
 Invest MORE in infrastructure
 Renewable Resources
22

Achieving a long term,
sustainable solution …
 Sustainable budgets provide a stable, long term solution
which:
 Smooths revenue and spending even during turbulent times
 Treats all generations equitably (provides each generation
with an equitable, base level of revenue which they can
choose to supplement or not)
 Encourages investment by providing a stable fiscal structure
 But requires fiscal discipline in order to avoid adversely
affecting future sustainable levels
 Limit spending – or adopt supplemental revenue measures
– to the sustainable level
23

27
TOTAL PERMANENT FUND (BILLION $) 53$
NON SPENDABLE ASSETS 46$
(1) CONTRIBUTIONS AND APPROPRIATIONS 39$
(2) UNREALIZED APPRECIATION ON ASSETS 7$
SPENDABLE ASSETS (ASSIGNED ASSETS) 7$
(3) REALIZED EARNINGS (EARNINGS RESERVE) 6$
(4) UNREALIZED APPRECIATION ON ASSETS 1$
Source: Alaska Permanent Fund Corporation.
See http://www.apfc.org/_amiReportsArchive/201505Proj.pdf

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