160108 gunnar knapp-an introduction to alaska fiscal facts and choices-january 8, 2015 02(1)(1)

1
AnIntroductionto
AlaskaFiscalFactsandChoices
GunnarKnapp
DirectorandProfessorofEconomics
InstituteofSocialandEconomicResearch
UniversityofAlaskaAnchorage
Gunnar.Knapp@uaa.alaska.edu
January8,2016
ISERpublicationsandpresentationsaresolelytheworkofindividualauthorsandshouldbe
attributedtothem,nottoISER,theUniversityofAlaskaAnchorage,ortheresearchsponsors.

Alaska’sfacesanextremelyseriousfiscalchallenge.
Wearespendingmorethantwiceasmuchasourrevenues.
Wearepayingforthedeficitbydrawingdownoursavings.
2

Wecan’tcontinuetorunhugedeficitslikethisyear’s.
Wedon’thaveenoughsavings.
3

Inthenextfewyears,
wewillhavetoclosethefundinggap
betweenourspendingandourrevenues.
Wewillhavetomakebigchanges
inwhatwespendorhowwepayforit—orboth.
4

From2005to
2014,oil
revenues
averaged90%of
Alaska’s
“unrestricted
generalfund
revenues”
(whichpayfor
state
government).
Alaskahasbeenextremelydependenton
oilrevenuestofundstategovernment.
5

6
Ourstaterevenuesareextremelysensitivetooilprices
—particularlyatpricesabove$80/barrel.

Oilpriceshavefallendrasticallyoverthepastyearandahalf
—andarecontinuingtofall.
7
Thepricewas
$34/barrelon
January5

ProjectedHistorical
$7.8billion
dropinoil
revenues
from2012
to2016
(88%drop)
Mostlybecauseofthefallinoilprices,ouroilrevenueshavefallendrastically.
Fallingoilproductionandhighercostsandcreditshavealsoplayedarole.
8
From2005
to2012oil
pricesand
revenues
rose
dramatically

Injustfouryears,
mostofthemoneywehadbeen
usingtopayforstategovernment
evaporated.
It’sgone.
That’swhywehaveabigproblem.

Won’toilpricesgobackupandsaveus?
•Ithappenedintheearly2000swhenwefacedasimilarfiscalchallenge.
•Itcouldhappenagain.
•Butitprobablywon’t.
–Thereisaglutofoilonworldmarkets
•Mostoilmarketanalyststhinkpriceswon’treboundabove$70-$90/barrel,
because
–Somuchoilproductionisprofitableatthoseprices
–Growthinworldoildemandisslowing
10
Hopingthatoilpricesriseisnotarealistic
orresponsiblesolutiontoourfiscalchallenge.

Evenifoilpricesrise,ouroilrevenueswilldecline
asoilproductionfalls.
11

From2005to2012,eventhoughspendingwasrising,
weranbigGeneralFundsurpluses.Since2013we
havebeenrunningbigGeneralFunddeficits.
ProjectedHistorical
12

Weusedthesurplusespriorto2012tobuildupoursavingsreserve.
Since2013wehavebeenrapidlydrawingdownourreserves.
Continueddeficitsofthisyear’slevelcoulddrainourreservesin2years.
13
ProjectedHistorical

Thisyear’s(FY16)projecteddeficitishuge.
FY16unrestricted
generalfundspending
$5.2billion
$3.6billion
(69%of
spending)
$1.6billion
Projected
deficit
Projected
revenues
$7,100
perAlaskan
$4,900
perAlaskan
$2,200
perAlaskan“PerAlaskan”
figuresarebased
on2014Alaska
populationestimate
of735,601.

Howwearespending$5.2billioninFY16
1,247(96%)is
K-12formula
641(55%)is
Medicaidformula

TrendsinGeneralFundspending,FY07-FY16
16

ThePermanentFundisworthmorethan$50billion.
Mostofthevalueisintheprincipal,whichwecan’tspend.
Wecanonlyspendthe“realizedearnings”intheearningsreserve,
whicharecurrentlyabout$7billion.
17

ThePermanentFundearnsbillionsofdollarsinmostyears,
whichgointotheearningsreserve.
18

Everyyear,wetakemoneyoutoftheearningsreservetopayfor
dividendsandinflationproofing.
19

InmostrecentyearsthePermanentFundhasearnedmorethanwehaveused
fordividendsandinflationproofing—sowehavebeenretainingsomeearnings
andtheearningsreservehasbeengrowing.
20

Likeoilrevenues,PermanentFundearningsarehighlyvariable—butthey
havebeengrowingastheFundgrows.Forthepasttwoyearstheyhave
beenmorethanouroilrevenues.
ProjectedHistorical

HOWWILLWEFILLTHEFUNDINGGAP?
Ouronlysignificantandpracticaloptionsaresomecombinationof:
Spendingcuts
Newrevenues
UsingPermanentFundearnings
Therearenoeasychoices.
Thefundinggapissolargethat
wewillprobablyneedtousealloftheseoptions.
22

Thechallengewithspendingcutsisfiguringoutwhattocutthatisn’t
mandated,essentialor“penny-wisebutpound-foolish.”
Verylittle
capital
spendingis
lefttocut
Itwouldbe
verydifficultto
cutdebt&
retirement
spending
Cuttingoiltax
creditscould
affectfuture
production
andrevenues
Mostcutswouldhavetocomefromstate
agencies—includingeducation&health

Therearemanypotentialoptionsfornewstaterevenues
—butnonewouldbeenoughtoclosethefundinggap.

Alaskanspaymuchlowerbroad-basedstatetaxes
thanresidentsofanyotherstate.
Alaska25

UsingPermanentFundearningswouldrequiresomecombinationof:
-ReducingPermanentFunddividends
-Reducinginflationproofing
-AddinglesstotheEarningsReserve
-DrawingdowntheEarningsReserve

Howwoulddifferentoptionsforclosingthefiscalgapaffect
Alaska’seconomyandAlaskans?
OptionEffectontheeconomyWhowouldbemost
affected
Cutting
spending
Fewergovernmentjobs&
income
Fewercontractorjobs&
income
Multipliereffectsoflower
spendingbygovernment
&contractoremployees
Governmentemployees
Contractoremployees
Tradeandserviceindustry
businesses&employees
Beneficiariesof
governmentservicesthat
arecut

OptionEffectontheeconomyWhowouldbemostaffected
Incometaxes
Salestaxes
Lesspersonalincome
spendingbyhouseholds
Richerfamilies(incometaxes)
Allfamilies(salestaxes)
Resource
industrytaxes
Lessbusinessincome
Fewerresourceindustry
jobs
spendingbyresource
industrybusinesses&
households
Resourceindustrybusinesses
Resourceindustryfamilies

OptionEffectontheeconomyWhowouldbemost
affected
Cutting
dividends
Lesspersonalincome
spendingbyhouseholds
Allfamilies
(Therelativeeffectswouldbe
greatestforpoorfamilies&
largefamilies)

OptionEffectonthe
economy
Whowouldbe
mostaffected
CuttingPermanentFund
inflationproofing
Addinglesstoordrawing
downthePermanentFund
earningsreserve
Noimmediateeffect
SlowerPermanent
Fundgrowth
Lowerfuture
PermanentFund
earnings
FutureAlaskans

WHENWILLWEFILLTHEFUNDINGGAP?
Themoregraduallyweadjust,
thesmallertheimmediatedirecteffectsontheeconomy.
Butthelongerwedelay:
Thebiggerthefuturedirecteffectsontheeconomy.
Thegreatertheriskofforceddrasticadjustments.
Thegreatertherisktoinvestorconfidence
Thegreatertherisktoourcreditrating
Thelowerourfutureinvestmentearnings
Thelesssavingsweleaveforfuturegenerations
31

Ourincome
-Whatweaddtooursavings
+Whatwetakeoutofoursavings
=Whatwecanspend
33
Overanyperiodoftimewhatwecan
spendisconstrainedbyourincomeand
whatweaddtoortakeoutofoursavings.
Fourkeychoicesthatweface
inthinkingabouthowtoclosethefundinggap

OurincomeOilincome
PermanentFundearnings
Othercurrentrevenues
Newtaxrevenues
-Whatweadd
tooursavings
RoyaltydepositstothePFprincipal
InflationproofingdepositstothePFprincipal
WhatweaddtothePFearningsreserve
WhatweaddtotheCBRF
+Whatwetake
outofour
savings
WhatwetakeoutofthePFearningsreserve
WhatwetakeoutoftheCBRF
=Whatwecan
spend
Governmentspending
Dividendspending
Anychoicethatwemakeaboutanythingaffectingour
revenues,spendingorwhatweaddtoortakeoutofour
savingsaffectsouroptionsforallourotherchoices.

1.Whatshouldweassumeabout
oilprices,oilproduction,andPermanentFundratesofreturn?
35
Oilprices&oil
productionaffectour
oilincome.OurincomeOilincome
Newtaxrevenues
-Whatwe
addtoour
savings
WhatweaddtotheCBRF
+Whatwe
takeoutofour
savings
=Whatwe
canspend
Governmentspending
Dividendspending
PermanentFund
ratesofreturnaffect
ourPermanentFund
earnings.

2.Howmuchdowewanttotaxourselvesorourindustries?
Our
income
Oilincome
Newtaxrevenues
-Whatwe
addtoour
savings
WhatweaddtotheCBRF
+Whatwe
takeoutof
oursavings
=Our
spending
Governmentspending
Dividendspending
36
Themoreweraisefrom
newtaxesthemorewe
canspend.

3.Howmuchdowewishtoaddtoortakeoutofoursavings?
Our
income
Oilincome
Newtaxrevenues
-Whatwe
addtoour
savings
WhatweaddtotheCBRF
+Whatwe
takeoutof
oursavings
=Our
spending
Governmentspending
Dividendspending
37
Howmuchweaddtoor
takeoutofoursavings
affectswhathowmuch
wecanearnandspend
inthefuture.
Thelesswespendnow,
themorewecanspend
inthefuture
—andviceversa.

4.Howmuchdowewanttospendongovernmentanddividends?
Our
income
Oilincome
Newtaxrevenues
-Whatwe
addtoour
savings
WhatweaddtotheCBRF
+Whatwe
takeoutof
oursavings
=Our
spending
Governmentspending
Dividendspending
38
Themorewespendfor
dividends,thelesswecan
spendforgovernment
—andviceversa.

Ouroptionsandchoicesforwhatwecanspend
arefundamentallyconstrainedby
ourfutureoilrevenuesandpermanentfundearnings.
Theyarealsouncertainbecausewedon’tknowwhat
oilpricesandpermanentfundratesofreturn.
Thefollowinggraphsillustratewhattherange
ofwhatwecouldspendmightbe
fordifferentcombinationsofassumptions.
39

Whatourcurrentoilandotherrevenueswouldbeatdifferentoilprices

WhatthePermanentFundwouldearnatdifferentratesofreturn
TheseprojectionsassumethatallearningsofthePermanentFundarespentexceptthoseneeded
toallowthefundtogrowattherateofinflation,sothatitsrealvaluestaysthesame.

Howmuchcanwespendperyearforgovernmentanddividendscombined?
fromourcurrentrevenuesources(oilrevenues,non-oilrevenues,andPFinvestmentearnings)
withoutreducingtheinflationadjustedvalueofthePermanentFundoverthenext10years?
5%6%7%8%9%
$402,9003,4504,0004,6005,150
$503,2003,7504,3004,9005,450
$603,6004,2004,7505,3005,900
$703,9004,4505,0505,6006,200
$804,2504,8005,3505,9506,500
DORforecast3,9504,5005,1005,6506,200
AveragePermanentFundRateofReturn
Price
ofoil
ItdependsonthepriceofoilandthePermanentFundrateofreturn.
Ifweraisenewrevenueswecouldspendmore.
IfwewantthePermanentFundtogrow
wehavetoraisenewrevenuesorspendless.

Howmuchcanwespendperyearforgovernment?
fromourcurrentrevenuesources(oilrevenues,non-oilrevenues,andPFinvestmentearnings)
withoutreducingtheinflationadjustedvalueofthePermanentFundoverthenext10years?
ItdependsonthepriceofoilandthePermanentFundrateofreturn
andonwhatwespendfordividends.
Ifwekeepdividendspendingatlastyear’stotal($1.4B)wecouldspend:
5%6%7%8%9%
$401,5002,0502,6003,2003,750
$501,8002,3502,9003,5004,050
$602,2002,8003,3503,9004,500
$702,5003,0503,6504,2004,800
$802,8503,4003,9504,5505,100
DORforecast2,5503,1003,7004,2504,800
Price
ofoil
AveragePermanentFundRateofReturn
Ifweraisenewrevenueswecouldspendmore.
Ifwespentlessfordividendswecouldspendmore.

Ourfiscaloptionsaren’tsobadcomparedwithmostotherstates.
•Mostotherstates:
–Don’thaveanyoilrevenues
–Don’thaveanyPermanentFundearnings
•That’swhymostotherstates:
–Spendmuchlessforgovernment
–Haveincometaxesand/orsalestaxes
–Don’tpaydividends
•Ourbasicfiscaloptionsaretobecomemorelikeotherstates:
–Spendlessforgovernment
–Taxourselvesmore
–Paysmallerdividends
44

TwopotentialapproachestousingPermanentFundearnings
tofundstategovernment
ApproachHistory/background
SenateBill114Introducedduringthe2015
legislativesession
Walkeradministration’s“sovereignwealth
fund”proposal
ProposalreleasedbyWalker
administrationFall2015
45

MajorAlaskastaterevenuesandspendingflows,FY16
General
Fund
Oil
royalties
Government
spending
PermanentFund
realizedearnings
Constitutional
Budget
Reserve
Fund
Permanent
Fund
principal
Permanent
Fund
earnings
reserve
Non-Oil
Revenues
Oil
taxes
Dividend
spending
Arrowsizesare
proportional
toFY16
revenue&
spendingflows

SB114approach:“Swap”fundingfordividendsandgovernment
General
Fund
Oil
royalties
Government
spending
PermanentFund
realizedearnings
Constitutional
Budget
Reserve
Fund
Permanent
Fund
principal
Permanent
Fund
earnings
reserve
Non-Oil
Revenues
Oil
taxes
Dividend
spending
Dividendswouldbepaid
from75%ofoilroyalties
Apayoutwouldgofrom
PermanentFundearningsto
theGeneralFundbasedon
5%ofaveragemarketvalue
overthepast5years.

Sovereignwealthfundapproach:Almostalloilrevenueswouldgotothe
PermanentFund,whichwouldmakeafixedpayouttotheGeneralFund.
General
Fund
Oil
royalties
Government
spending
PermanentFund
realizedearnings
Constitutional
Budget
Reserve
Fund
Permanent
Fund
Non-Oil
Revenues
Oil
taxes
Dividend
spending
Dividendswouldbepaid
from50%ofoilroyalties
Afixedannualpayoutwould
gofromthePermanentFund
earningsreservetothe
GeneralFund
(estimated@$3.2B)

160108 gunnar knapp-an introduction to alaska fiscal facts and choices-january 8, 2015 02(1)(1)

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160108 gunnar knapp-an introduction to alaska fiscal facts and choices-january 8, 2015 02(1)(1)