Implementing Governor Hammond's 50/50 Plan (Fairbanks "Budget Blitz" 2.16.2016)

Implementing Governor
Hammond’s “50/50” Plan …
and one other thing
Fairbanks “Budget Blitz”
February 16, 2017
Brad Keithley (bgkeithley.com)
Founder, Alaskans for Sustainable Budgets

Agenda
• Some background
• Governor Hammond’s “50/50” Plan
• What is the objective of the Permanent Fund
• How does the Permanent Fund work
• How would 50/50 work
• Why maintaining the PFD at 50% of earnings is
important
• “And one other thing”: Some thoughts on the
upcoming oil tax debate
Feb. 16, 2017 Alaskans for Sustainable Budgets 2
Alaskans for Sustainable Budgets
www.ak4sb.com

Some Background

What is the issue
• We don’t disagree that the state is facing a serious
fiscal challenge, but we do question how deep it is
• And the issue doesn’t just involve the state budget:
• Most of the alternatives also affect the private sector, and
• Most of the alternatives also affect future Alaskan
generations
• Finally, Alaska is in an economic recession: we should avoid
Government making it worse
• The issue should be what is in the best interests of the
overall Alaska economy and treats all Alaskans fairly,
not just what quickly raises more revenue for
government

How big is the fiscal problem (the
Administration’s view) …

But is it really that bad …
Administration forecast v. EIA (oil price) &
projected decline rate (production) …

And what are the savings levels …

Plus, there are knock‐on effects
Effect on overall Alaska income …

And what about all Alaskans
A $1000 PFD cut
translates into:
• A loss of 21.5% of
the disposable
income of the
lowest 10% (by
income) of Alaska
households
• But only 0.6% of
the highest 10%

...that the Permanent Fund (or other
revenue measures) don’t have a role to
play in finding a solution, but:
• Need to accurately gauge the size and
urgency of the problem,
• Need to consider the impact on the overall
economy, and
• Need to consider effect on all Alaskans
Do what is necessary, don’t overcorrect
We aren’t saying …

Back to Basics:
What is the objective of the
Permanent Fund

Governor Jay Hammond
“I wanted to transform oil wells
pumping oil for a finite period into
money wells pumping money for
infinity.
… [Once the “money wells” were
pumping,] each year one‐half of
the account’s earnings would be
dispersed among Alaska residents
…. The other half of the earnings
could be used for essential
government services.”
‐‐ Diapering the Devil, at 15, 19

How does the
Permanent Fund work

Alaska Constitution, Art 9 §15
“At least twenty‐five percent of all
mineral lease rentals … received by
the State shall be placed in a
permanent fund, the principal of
which shall be used only for those
income‐producing investments
specifically designated by law as
eligible for permanent fund
investments. All income from the
permanent fund shall be deposited
in the general fund unless
otherwise provided by law.”

A One Stop Information Shop

A little easier on the eyes
•Permanent Fund
principal (corpus)
• 25% of mineral
revenues
• Unrealized gains
(retained in fund)
•Earnings
• Statutory net
income (SNI) (i.e.,
realized cash)

Where do the earnings (SNI) go
Once the “money wells”
are pumping, each year:
“… one‐half of the
account’s earnings
would be dispersed
among Alaska residents”
• Done: PFD
“…. The other half of
the earnings …”
• NOT “for essential
government services”
• Instead “inflation
proofing” and
“earnings reserve”

FY 2017 Activity & Balances

The key to unlocking the “Other half”:
So‐called “Inflation proofing”
The size of the “other half”
depends on “Inflation Proofing”
Without IP With IP
FY 2018 $1.5 B $0.4 B
FY 2019 $1.5 B $0.5 B
FY 2020 $1.6 B $0.6 B
FY 2021 $1.6 B $0.6 B
FY 2022 $1.7 B $0.7 B
… [Once the
“money wells”
were pumping,]
…. The other half
of the earnings
could be used for
essential
government
services.”

Is separate
"Inflation Proofing” necessary
Permanent Fund Corporation Executive Dir. Angela
Rodell, minutes of Feb. 16, 2016 testimony before
Senate State Affairs (https://goo.gl/AOLwbr):
“MS. RODELL explained  that … [t]he current  Permanent
Fund  asset allocation consists of 80 percent self‐inflation
proofing  funds. Their market value already incorporates
the  concept  of  inflation. Inflation  proofing  as  designed
forty  years  ago  is  not as necessary today.
MS. RODELL noted  that … [i]nflation proofing … is no
longer necessary  for preserving the purchasing power
[i.e., to protect against inflation].”

Is separate
Sen. Lesil McGuire, minutes of Feb. 16, 2016
testimony before HFIN (https://goo.gl/MgpCpa):
“Senator McGuire … relayed that Angela Rodell,
Executive Director, Alaska  Permanent Fund
Corporation reported  that … roughly 80  percent
of all  of the  funds' assets self‐inflation proof. …
She announced that the yearly budget line item
of between $703 million to  $1 billion to  inflation
proof the fund was ‘in effect, a direct injection of
new capital into the corpus.’”

Is separate
Walker Administration’s “FY 2018 10‐year (fiscal)
plan,” 12.15.2016 (https://goo.gl/R8GxSI), which as
part of moving to a use of Permanent Fund earnings
based on percent of market value (POMV) also
proposes to eliminate separate inflation proofing:
“Since earnings of the Permanent Fund have
averaged 10 percent annually, the fund will be
protected from the effects of inflation.”

The goal of “Implementing 50/50”
Achieving Governor Hammond’s original
purpose:
… [Once the “money wells” were pumping,]
each year one‐half of the account’s
earnings would be dispersed among Alaska
residents …. The other half of the earnings
could be used for essential government
services.”

How would 50/50 work

Changes the revenue line …
Feb. 16, 2017 Alaskans for Sustainable Budgets Corrected 25

... and the deficit

The overall effect
Traditional “Other
half”
Draw on
Reserves
Reserves
Balance
Year Spending Oil Other
FY 2017 $4.30 $12.77
FY 2018 $4.39 $1.10 $0.52 $1.54 $1.23 $11.54+
FY 2019 $4.47 $1.34 $0.53 $1.53 $1.07 $10.47+
FY 2020 $4.56 $1.36 $0.55 $1.60 $1.05 $  9.42+
FY 2021 $4.65 $1.38 $0.56 $1.77 $0.94 $  8.48+
FY 2022 $4.75 $1.43 $0.58 $1.90 $0.84 $  7.64+
Total $5.13
Next five years using Administration’s revenue numbers, if
spending held to $4.3 adjusted for inflation & pop growth:

Protecting “self‐inflation proofing”
• “Self‐inflation proofing” contemplates that draws
from the earnings reserve roughly mirror the so‐
called “real” (after inflation) rate of return
• The level of earnings realized over time appears
largely to be consistent with that objective, but
could be subject to manipulation going forward
• For that reason and others, there are various
proposals to set a firm draw rate (Governor: 5.25%,
Sen. Stedman: 4.5%, Rep. Seaton: 4.75%, Former
Sen. & PFC Board Member Steve Rieger/PFC: 5%)

The effect of various draw rates
FY 2018 ($B) Current
(Dunleavy)
5.25%
(Gov)
5.0%
(Rieger)
4.75%
(Seaton)
4.5%
(Stedman)
PF principal
only ($46.72)
$1.54
$1.23 $1.17 $1.11 $1.05
PF+ERA
($56.44)
$1.48 $1.41 $1.34 $1.27
• In addition to draw rate, a key consideration is what the
draw is calculated on
• The PF principal only (leaving the ERA to be used as savings), or
• The PF + ERA (essentially converting the ERA to principal)
• These assume the resulting earnings stream is split 50/50
between the PFD and “essential government services”

Alaska is in a recession
(or, “Why is it important to keep the PFD at 50%)

Economic role of the PFD
Effect: Creates a private
Alaska economy more like
Texas than Angola
• Under Statehood Act, Alaska
can’t privatize mineral interest
• Thus, absent PFD, Alaska private
economy receives no oil & gas
royalties – all goes to the
government
• Cutting the PFD moves toward
Angola, away from Texas

Cutting the PFD hurts
the overall Alaska economy
• Not all fiscal options have
the same impact on the
overall economy – some
are worse than others
• Cutting the PFD has the
largest adverse impact
on the overall economy:
• By income of all the state’s
fiscal options, and
• By any measure of all the
state’s revenue options.
Short‐Run Economic Impacts of Alaska
Fiscal Options, at III‐9, A‐15 (March 2016)

… and increases poverty and
income disparity
‘For every $100 million raised with
PFD cuts, the ten percent of Alaskan
households with the lowest income
lose 3.3 percent of per‐capita
disposable income, compared with
only 0.1 percent among households
with the highest incomes.’
Under SB 128 ($650MM+ PFD cut):
• Lowest ten percent would lose
more than a 20% of their annual
disposable income immediately,
• Wealthiest ten percent will lose
less than 1% of theirs.
“Reducing the PFD by $1,000
will likely increase the
number of Alaskans below
the poverty line by 12‐15,000
(2% of Alaskans).”
Poverty Income Disparity

The effect on the overall economy
• HB 115 (Rep. Seaton) uses both PFD cut (to 33% of
earnings) and income tax to raise revenue
• Saves some jobs, but lowers overall income,
increases poverty levels and increases income
disparity

Why we focus more on “income”
• Better measure of the amount of money circulating
in the economy
• Critically important during a recession
• “Recessions generally occur when there is a widespread
drop in spending.”
• The fact that jobs remain positive while income
goes down reflects the fact that some with jobs are
either not spending marginal dollars (saving) or
spending Outside
• Maintaining spending in the economy is important
to dealing with the recession and maintaining a
strong economy

And why we focus on low income
• Not a “bleeding heart” or “populist” concern (as
some have suggested)
• But ruthlessly economic
• Increased poverty (or near poverty) levels add to
state costs (operating budget)
• As importantly, ISER data shows that low income
Alaskans spend all or almost all of their marginal
dollars (as opposed to saving/deferring) and more
of it stays in‐state (as opposed to going Outside)
• Income disparity also creates significant education,
job skills issues

… Finally, “one other thing”

A moment on oil taxes (Alaska’s
“other” fiscal policy)
Oil production generally is tied to investment levels
(an example from 2013 testimony)…

… and investment levels …
… in a given region are tied to the competitiveness of
that region’s returns
• There are more opportunities globally than there are
investment dollars
• Those regions that succeed are those that offer better
returns
• There are many more things involved in
determining competitiveness than tax rates (e.g.,
regulatory lag, drilling costs, infrastructure)
• But tax rates are the one thing over which state
government has the clearest control

Looking (again) at oil taxes
• Alaska went through an extensive competitiveness
review in 2013 in developing SB 21
• Set production tax rates at levels and using a method
which the majority determined achieved
competitiveness
• From my perspective, SB 21 has succeeded in restoring
Alaska’s relative share of global investment in a very
difficult time
• Now we appear to be embarking on another review
of oil taxes and credits
• HB 111 (House Nat Res) would make significant changes

Our view
• Focus should be on what is necessary to maintain
competitiveness for investment
• Maintain “fair share” of global investment, and
• “Fair share” of revenues will follow
• Current production tax rates (SB 21) are working
• Attracting investment that has enabled Alaska to
maintain activity during a huge global downturn
• There is a problem with reimbursable oil tax credits
• Not competitively required (88 Energy: “globally unique
fiscal system”)
• “Investment” not producing a return equal to what
same money could earn through Permanent Fund

Conclusion
• The earnings stream from the PF is not being used
to its maximum potential to help solve the fiscal
crisis
• Hammond: “The other half of the earnings could be
used for essential government services.”
• Fully implementing Governor Hammond’s
“50/50” plan helps balance the budget and
avoids the significant adverse economic effects
of cutting the PFD (or other tax measures)
• Helps build a sustainable budget and overall
economy

www.ak4sb.com

Implementing Governor Hammond's 50/50 Plan (Fairbanks "Budget Blitz" 2.16.2016)

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