Wednesday, February 7, 2018

Hmmm, a POMV approach may produce a higher PFD than the current statute after adjusting for inflation proofing

Recently, we wrote a piece in which we explained that the current formulation of the PFD is not entirely as Governor Hammond intended, once the state starts using the "other half" of the earnings stream for "essential government services." See "Is the current formulation of the PFD what Governor Hammond intended?" (Jan. 2018).

Our point was that due to how the so-called "inflation proofing" provisions work, under the current statute the earnings available after inflation proofing are not split 50/50 between residents (through the PFD) and government (through the earnings reserve) as Governor Hammond intended.

Instead, using FY 2016 as an example, we demonstrated that while residents receive 50% of the current distributions, government received only 27%. The remaining 23% was available to neither residents nor government but instead reinvested in the Permanent Fund corpus.

As a result, between the portion split between residents and government, residents received roughly 65% of the earnings made available for distribution and government 35%. This departs from Governor Hammond's vision, expressed in Diapering the Devil, that once the "money wells" created by the Permanent Fund started 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.

While not our principal point, in the course of writing the piece we commented, based on some prior work, that in addition to imbalancing the split between residents and government, the current statutory inflation proofing mechanism also appeared to overcompensate for inflation. We speculated -- as we had also in an earlier November piece -- that the percent of market value (POMV) approach favored by some to calculate distributions from the Permanent Fund might actually result in a more accurate assessment, and thus a better net result.

In response, some readers of the January piece appropriately challenged us to prove that latter statement. Over the course of the past couple of weeks we have worked to analyze the results under the two approaches.

It turns out, based on what we believe is an appropriate methodology for comparing the two, the POMV approach, in fact, results in a higher overall level of net distribution after inflation proofing than the current approach.

Put another way, assuming a 50/50 split in distributions between residents and government, PFD's would be higher under a POMV (5%) approach than under the current statute, once adjusted to reflect an equal split of the earnings remaining after current inflation proofing.

Largely because of the lingering effects of FY 2009 on Statutory Net Income (when SNI was a -$2.51 B), looking back over the last 5 years (FY 2014-2018) the difference would have been significant. The annual distribution net to the PFD would have averaged roughly $245 million higher under POMV (5%) than under the current statute, once adjusted to reflect an equal split of the earnings remaining after inflation proofing.

Going forward the projected differences are not as significant. Using Permanent Fund Corporation (PFC) projections, for example, over the 10-year period between FY 2019 and 2028 (a copy is available here), the difference between the two, net to the PFD, would average roughly $60 million per year (or, at 650,000 applicants, a little less than $100 per PFD check).

But the fact there is some difference both demonstrates that the current methodology likely is, in fact, overcounting for inflation and that, far from being adverse to the PFD, the use of POMV may actually be helpful, if the split remains as intended by Governor Hammond and other founders, equally between residents and government.

Of course, the results depend on the approach taken.

In calculating the POMV distribution we largely adopted the approach reflected in SB 26, using a rolling five year average of the market value of the Permanent Fund as the base, with a draw rate of 5.25% for 2019 and 2020, and 5% before (for the lookback) and thereafter. We calculated the average value of the Permanent Fund using the PFC's most recent estimates for such balances between now and 2028. The average for each year was calculated by averaging the end of the previous year and the end of the current year.

In calculating the distribution under the current statute we used the PFC's most recent estimate of Statutory Net Income (SNI) and Inflation Proofing (IP). To determine the net available for distribution after inflation proofing we subtracted the number for Inflation Proofing from Statutory Net Income. To avoid timing distortions, we used the five year rolling average for each, as the current statute requires for the calculation of the PFD.

As should be expected, the results are heavily influenced by the POMV draw rate used. As noted above, we used the 5% rate included in SB 26. Using a 4.5% rate reverses the results, with the current approach producing a better result, even after subtracting the inflation adjustment.

But at a 5% draw rate a POMV approach produces a higher PFD than under the current statute, once adjusted to reflect an equal split of the earnings remaining after inflation proofing.

We believe that is a significant fact to keep in mind as we continue the current discussions.

For those interested, the detailed calculations are available at the spreadsheet below, or available also for download here.

Thursday, January 25, 2018

Is the current formulation of the PFD what Governor Hammond intended?

As we spend more and more time on the issue, increasingly we are coming to the view that the current formulation of the PFD is not entirely as Governor Hammond intended, once the state starts taking its "other half" of the earnings stream.

Here is what Governor Hammond said in Diapering the Devil, a book which, while published posthumously, was taken from manuscript and notes he had been working on before his passing and is consistent with his earlier writings in other books on fiscal policy.

The first relates to the creation of the Permanent Fund itself (at p. 15):
I wanted to transform oil wells pumping oil for a finite period into money wells pumping money for infinity. …
The second focuses on what to do with the earnings, once the “money wells” were pumping (at p. 19):
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.” 
Given the backdrop of how Alaska's mineral interests are owned, the so-called 50/50 split makes sense and is one we have -- and will continue to -- defend strongly on these pages.

But that is not entirely how the current formulation of the PFD works.

Instead, using FY 2016 numbers (the last year the Governor or the legislature didn't override the current statute), this is how the current statute (AS 37.13.145) operates:
  • Overall earnings (5-year average): $2.746 B
  • PFD: $1.373 B (50%)
  • Retained in the Earnings Reserve Account (i.e., the state's share): $0.749 (27%)
  • "Inflation proofing" (i.e., returned to the corpus): $0.624 B (23%)
As noted, under the current formulation the state's share was only 27% of the earnings stream, not the "other half" envisioned by Governor Hammond.

The reason for the shortfall is that, under the current statute, the portion used for "inflation proofing" -- purportedly the amount necessary to keep the Fund whole against inflation -- is taken entirely from the "other half" of the stream, instead of being divided equally between the "residents'" share and the "state's" share.  As we wrote on these pages in November, we believe inflation proofing benefits both sides (residents and state) of the split, and thus, should be borne equally. See "Notes from the Alaska Fiscal Cliff: Our Proposed Fiscal Solution" (Nov. 2017).

Before the past two years the fact that the split wasn't entirely as envisioned by Governor Hammond didn't make much of a difference.  Because the state wasn't using it's share of the split anyway, there really wasn't any significant, current harm from the way that the statute operated.  It simply took some of the state’s share and transferred it to Permanent Fund principal, not a bad place for surplus earnings.

Now that the state is beginning to take a share of the earnings, however, the formulation of the statute does make a significant difference. It reduces the state's share substantially below the "other half" envisioned by Governor Hammond.

As we also wrote in our November piece, we believe that the current inflation proofing formula overstates the current costs of inflation and should be revised as well.  We believe that a POMV approach could be a good solution to that (as long as the resulting earnings available for distribution continue to be split 50/50 between the private sector (residents) and state).

But that is a secondary point.  The primary point is that, even if inflation proofing is reduced to a more appropriate level and works perfectly, the current statute still won't reflect Governor Hammond's 50/50 split because all of whatever portion is set aside for inflation proofing comes from the state's share.

As we approach implementing Governor Hammond's full vision -- splitting the use of earnings from the state's "money wells" evenly between the private sector (residents) and state government -- we believe it's important to ensure that the split is done right.

For that reason, and as we outlined in our November piece, we favor making changes to the statute both to revise the manner in which inflation proofing is calculated and to ensure that the resulting transfers to the principal are shared equally between the residents' 50% (the PFD) and the portion made available for state spending.

And for that same reason we also will oppose simply moving the current statute to the Constitution.  As we explain above, once the government starts taking its share of the earnings the current statute doesn't fully achieve Governor Hammond's original intent.  Until it is corrected we believe locking that approach into the Constitution would be a significant mistake.

Tuesday, January 2, 2018

Analyzing the Governor's Proposed FY 2019 Budget: Part 2 (formula spending)

Right click to enlarge
Last week we walked through an overview of the Governor's proposed FY 2019 budget. See Analyzing the Governor's Proposed FY 2019 Budget: Part 1 (an overview).  

In this column we take a deeper dive into the major formula programs that, as occurs also at the federal level, drive a large part of state government spending.

What are the "formula programs'

For purposes of its 10-year forecast (above), OMB lumps three "Agency Operations (formula)" categories together.  The included categories are:
  • Education (K-12) Foundation and Pupil Transportation (which together are referred to by OMB as the Education Formula programs), 
  • Medicaid, and 
  • What OMB refers to as the "Other Formula" programs (which are composed of three fairly small programs administered each by the Departments of Health & Social Services (non-Medicaid), Administration and Military & Veterans Affairs). 
In the above spreadsheet, we have hi-lited in yellow the combined, projected spending number for the three programs. They constitute approximately 45% of total FY 2019 UGF spending ("Budget (before Dividend)").

For purposes of this column we also treat expenditures for debt, retirement (PERS/TRS) and oil tax credits -- which are categorized in the budget as "Statewide" expenditures -- as formula programs, as they are driven also by formula calculations external to the annual budget process. We have hi-lited those in blue.

Those additional, "Statewide" programs constitute 11% of total FY 2019 UGF spending. 

Combined, all of the formula programs -- those included in the "Agency Operations" and those included in "Statewide" -- account for approximately 56% of total FY 2019 UGF spending.

"Agency Operations" formula spending grows substantially over the 10-year period

OMB's forecast contemplates a significant increase in the three categories of "Agency Operations" formula spending over the 10-year period.

Based on OMB's 10-year forecast, combined the three formula categories increase by 22% over the 10-period, a compound growth rate of 2.25%, OMB's assumed inflation rate.

But OMB readily admits that may be too low. 

In an earlier version of the 10-year forecast included as part of the Governor's support in October's Special Session (the "October 10-year forecast"), OMB admitted  that:
... if health care costs including Medicaid grow at historic rates rather than simply tracking inflation; if K-12 spending grows at historic rates rather than inflation; if the federal government shifts health care costs onto states ... the budget gap [could widen] by hundreds of millions of dollars ....
All of those contingencies are governed by the formula programs. Under the current formula approach, if those costs go up so will spending, automatically by simple operation of the formulas.

As noted above, as it is the Agency Operations formula programs already represent approximately 45% of total FY 2019 UGF spending.  Because OMB escalates all spending in that budget segment (both formula and non-formula) by roughly the same percentage, in the forecast the percentage of overall Agency spending arising from the formula programs remains fairly constant throughout the entire 10 year period.

If, as noted in the October 10-year forecast, however, spending determined by the formula programs escalates more rapidly, on its current trajectory it will not be surprising to see Agency Operations formula spending alone drive more than half of overall spending by the end of the period.

"Statewide" formula spending also rises

Unlike "Agency Operations" formula spending, OMB does not tie changes in "Statewide" formula spending to inflation.  Each of those programs have separate drivers.

Projected contributions to the state's "retirement" accounts (PERS/TRS) over the 10-year period, for example, increase by roughly 75%.  That is because the state currently uses an amortization approach which enables it largely to kick the retirement spending "can" down the road, imposing a greater share of retirement costs in later years.

The result is to make current spending levels artificially lower.  

Even that increase potentially understates the rise in costs, however.  Unlike most other programs across the country, Alaska continues to assume an 8% rate of return in the portion of its investment portfolio set aside for the retirement accounts. If -- as other programs increasingly assume -- the realized rate turns out instead to be in the range of 6%, the shortfall required to be made up in future years will be substantially higher.

Payments into the oil tax credit program similarly rise over the 10-year period, increasing by roughly 433% between FY 2019 and FY 2028.  As with the retirement contributions, the reason is because of the proposed adoption of a method (the Administration's proposed "Oil & Gas Exploration Credit & Repayment Plan") which defers current spending required under the existing statute to future years.

Funding the oil tax credit program through the Administration's proposed plan reverses the change over time which otherwise would result under the current oil tax credit statute. If the current statute remains in place, spending on oil tax credits will drop to zero by the end of the period (from a projected FY 2019 level of $206 million to zero in FY 2028) rather than rise.

Offsetting the trend of rapidly rising spending in other categories, projected debt costs decrease over the same period by 55%.  But that is somewhat misleading.  As OMB's October 10-year forecast admits, that amount assumes "[n]o new debt is issued - payments fall as outstanding obligations are paid off."  If new debt is issued -- as likely will be the case if for no other reason that to refinance existing debt -- the projected spending levels will rise.

Even after factoring in the reduction in debt costs, the three formula programs included in the "Statewide" spending category still rise by roughly 34% over the 10-year period.  If, as likely, new debt is issued or retirement spending rises (due to a restatement of the assumed rate of return on invested assets) the growth in spending will be even greater.

What does that mean for this coming session

Based on the assumptions made in OMB's10-year forecast, combined formula spending already accounts for approximately 56% of overall UGF expenditures in FY 2019, increasing slightly to 57% by FY 2028.

But if -- as OMB put it in the October 10-year version -- "
health care costs including Medicaid grow at historic rates rather than simply tracking inflation; if K-12 spending grows at historic rates rather than inflation; if the federal government shifts health care costs onto states," or if "the retirement system misses earnings targets or has other negative experiences," formula spending easily could  exceed -- and perhaps substantially exceed -- 60% of overall UGF expenditures by FY 2028.

As OMB's 10-year forecast admits, the amount of overall spending that is formula driven is unsustainable even at projected levels without support by significant amounts of "new revenues." The level of "new revenues" required to support overall spending if any of the "ifs" occur will be even greater.

As recent history has demonstrated it takes a substantial amount of time and effort to address state spending of any sort, much less the challenges presented by reevaluating the formulas that underlie much of it.  The fiscal challenges created by permitting the current formulas to continue unabated are clear, and should be addressed now, before the problems they present become even worse.

If it were us, we would dedicate a substantial part of the upcoming legislative session specifically to "looking under the hood" of each of the various formula programs and finding ways to bring them under control.  If the legislature chooses not to do that (or even if it does but fails to produce significant results) we would make "formula reform" a significant part of our campaign during the upcoming election cycle.  

We know that Alaskans for Sustainable Budgets will do precisely that.

In our next installment of this series we will look at the Administration's proposed "Oil & Gas Exploration Credit & Repayment Plan."  As we said in our first column in this series, questions along the way are encouraged. Feel free to post them either in the comments section of this page, or on any of the Facebook or Twitter pages where we will be posting links to this and future columns.

Tuesday, December 26, 2017

Analyzing the Governor's Proposed FY 2019 Budget: Part 1 (an overview)

Right click to enlarge. Also available from the OMB website (p. 16).

Over the past week we have taken the time to work through the Governor’s proposed FY 2019 budget. Following up on that, over the next couple of weeks we intend to write a series of columns taking a deeper dive into various aspects we think are important.

Today, however, we start with a simple overview, using as the baseline a spreadsheet from among the various materials published on the OMB website in support of the budget. The spreadsheet we are using (above) -- and will continue to use throughout -- is the Administration's 10-year fiscal forecast. The reason we are using that is because Alaska’s current fiscal situation isn’t a one-year phenomenon. Instead, as with the federal budget, there are various structural issues that, if not addressed in the near term, will cause the problems we currently are experiencing to continue to occur year after year. 

Using OMB's 10-year forecast as a baseline enables us to put those in perspective.

But using OMB’s 10-year forecast comes with its own issues. For the first time OMB’s materials include what they refer to as a “transparent budget” which attempts to eliminate the accounting tricks used in the past to understate UGF spending. We commend them for the effort, but unfortunately they have not used that approach in crafting the 10-year forecast. As a result, we will need to make some adjustments to the 10-year forecast as we walk through it in this and subsequent columns in order to remove the effects of the various accounting tricks.

The spending level we will focus on throughout this effort is referred to on the spreadsheet as the “Budget (before Dividend).” We have hi-lited that in yellow on the above sheet. We are using that both because it best aligns with the so-called UGF numbers used in the past, and avoids the various distorting effects created by including all or a portion of the statutory PFD in the state spending numbers.

Focusing on that, the Governor’s 10-year forecast proposes to set FY 2019 spending at $4.58B, which rises to $5.10B by FY 2023 (5-year) and $5.60B by FY 2028 (10 year).

But as mentioned above, those numbers need to be adjusted for accounting tricks.

The footnote to the spreadsheet indicates that after adjusting for those, FY 2019 spending rises to about $4.7B. But that number still largely excludes oil tax credits (which the Governor assumes are covered by a yet-to-be-approved bond issuance, and as a result, are essentially removed from his proposed FY 2019 spending levels). Including those adds an additional $180 million to FY 2019, bringing adjusted FY 2019 spending to around $4.9B.

There also is a question about how to treat the additional spending included in the Governor’s proposed “Alaska Economic Recovery Act.”

The Governor proposes to fund that with a so-called “temporary” payroll tax, which would make the expenditures DGF (designated general fund) spending. But we have heard some talk about agreeing to all or part of the spending (as “needed” capital spending), but without the tax. If so, that would raise adjusted FY 2019 UGF spending by another $280 million, to roughly $5.2B, or approximately $600 million (13%) more than the initial level shown on the spreadsheet.

While not all of those adjustments carry through to future years, some do, which likely means projected adjusted FY 2023 (5 year) spending exceeds $5.25B and projected adjusted FY 2028 (10 year) spending exceeds $5.75B.

That compares with adjusted FY 2018 spending (i.e., excluding accounting tricks) of roughly $4.9B. That means the Governor's proposed adjusted FY 2019 spending is roughly $100 million to $300 million (2 - 6%) above adjusted FY 2018 levels, and adjusted FY 2023 (5 year) and FY 2028 (10 year) spending is roughly 7% and 17%, respectively, above FY 2019 levels.

That’s enough to digest for now. We will follow up next by focusing on where we are -- and where we are headed -- under various of the current formula programs.

Questions along the way are encouraged. Feel free to post them either in the comments section of this page, or on any of the Facebook or Twitter pages where we will be posting links to this and future columns.

Saturday, November 18, 2017

Some argue accelerating the payment of oil credits is more valuable to Alaskans than coming current on the PFD. They are wrong.

Earlier this year we wrote a couple of columns comparing the legislature's treatment of the PFD and oil credits.

The first focused on whether in a then-upcoming vote the legislature would treat both according to the current Alaska statutes. Today's vote will demonstrate whether Alaska legislators believe in the rule of law (July 2017).

The second was written after the vote was taken, in which the legislature upheld the rule of law as applied to oil credits, but  effectively voted to default on the state's statutory obligations to Alaska's citizens with respect to the PFD.  The Alaska Legislature tosses out the Rule of Law (July 2017).

A recent post now appears to argue for granting a priority for an even greater level of payments to oil companies over PFD payments based on some unsupported claims about the jobs impact.

The post is circled in the following string:

The string started with a tweet from the Alaska Journal of Commerce claiming that so-called "unpaid" tax credits had played a role in "thwarting" efforts by a couple of Cook Inlet oil companies this coming drilling season. 

As with other, previous hyperinflated claims by the Journal on the subject, that's an overstatement. Webster's defines "thwart" as follows:

a :to oppose successfully :defeat the hopes or aspirations of

b :to run counter to so as to effectively oppose or baffle :contravene
Neither applies in this case.  It is inaccurate to claim that the state "opposes" the efforts of the companies.

As those who have read the applicable statutes will know, all that the state has done with respect to the two companies is to decline accelerating payments of certain "tax credits" on a faster schedule than agreed between it and the companies. 
Finally, a balanced piece on cashable oil tax credits (Aug 2017).

To claim the state's failure to accelerate future payments into the present as now sought by the companies "thwarts" the companies' efforts is the same as claiming that homeowners "thwart" a mortgage company from making additional profits when the homeowners fail to pay their full 20-year mortgage obligation all at one time.

Both are obligations due over time. The failure to pay early doesn't "thwart" anything. It simply observes the parties' original agreement.

The PFD became involved in the latest exchange when we responded that, compared to the Journal's hyperinflated oil credit claims, cutting the PFD below statutory levels -- something the Walker Administration and the legislature actually did do earlier this year -- had "the largest adverse impact" on the overall economy of any of the so-called new revenue options and was, "by far," the worst alternative for Alaska families. 

Those statements are based on analyses published last year and earlier this by the University of Alaska - Anchorage's Institute of Social and Economic Research (ISER). Short-run Economic Impacts Of Alaska Fiscal Options (March 2016)Effect of Alaska Fiscal Options on Children and Families (February 2017).

The reply to our comment attempts to dismiss the ISER analyses, but without offering any competing, professional analysis in return.

That strikes us as sort of the Alaska version of "alternative facts." On the one hand we have detailed analyses by a preeminent, non-partisan set of professional economists who follow the Alaska economy closely, and on the other we have ... rank speculation by some with a vested interest in undermining the conclusions.

Just as it is hard to give any weight to most other claims of "alternative facts," so it is with these unsubstantiated claims.

Applying the factors contained in the ISER analysis, the annual PFD cuts of the last two years have resulted in a reduction of somewhere between 3,900 and 6,250 full time equivalent (FTE) Alaska jobs. Using a consistent evaluation approach (the same one used also to measure the impact of other new revenue options), ISER has concluded that level of job loss is more than would have occurred had the resulting "new revenues" (to government) been raised any other way.

Those who claim otherwise offer no -- none, nada, zip -- in the way of professional economic analysis to support their claim.

In the post one of those advocating for accelerated payments to the oil companies tries a new tack, comparing the effect on jobs between the failure to accelerate the payments and those generated by the PFD.

Certainly, any job loss is a problem in a recessionary economy. But i
t's hard to get exorcised about the effects when the state is following its own law.

Moreover, the post overstates the potential effect of accelerating the payments.

Of the 2100 jobs lost in the oil & gas sector cited in the post, likely few -- and perhaps very few -- are tied to the state's decision not to accelerate the statutory payment schedule. Most are likely tied to other reasons, such as the wind down of the Pt Thomson project and workforce efficiencies implemented as a result of the drop in oil prices.

But even if you assume that 15% of the overall job loss could have been avoided by accelerating the payments and even if you assume the full 10:1 instate multiplier on that level implied by a recent McDowell Group study, that still produces only 3000 or so total jobs, well short of the 3,900 to 6,250 arising from the PFD cut.

There are other reasons why maintaining the current PFD is important -- the positive effect on overall Alaska income, Alaska families and poverty levels to name three. 
It's still the economy, stupid (Sept. 2017).

But even when focused only on jobs the numbers remain compelling.

We certainly agree that the state should meet its financial obligations made during the oil credit program. But those obligations have been tied explicitly since the outset of the program to the level of funds the state receives during the same period from production taxes. The oil companies and their bankers knew and accepted those limitations on the state's payment obligations going in.

There is no justification for bailing those companies out of the effects of those limitations now, especially when at the same time the state is undeniably delinquent on its statutory obligations to its own citizens. 

As the jobs numbers alone show, putting contingent oil company claims ahead of fully matured statutory obligations to Alaska's citizens is a recipe for disaster, especially in a recession. 

Tuesday, November 14, 2017

A blast from the past explains some of the present ...

Recently for another purpose, we were paging back through our primary blog to identify when it was we started voicing concerns about the state's fiscal situation. (The answer is May 2011.)

Along the way, however, we ran across a piece from July 2012 that answered in one fell swoop something that has puzzled us for the last couple of years as the Alaska Senate R's increasingly have gone off the deep end by first, two sessions ago, passing a bill permanently to tax statutory income from the PFD (what some euphemistically refer to as "cut" the PFD) at more than 50% and then, last session, not only doing that again but essentially giving up on cutting government spending further and cutting the PFD instead.

The piece discusses what then was a new (in 2012) -- and apparently still available -- website sponsored by the so-called "House Special Committee on Fiscal Policy." According to the Chair of the Special Committee, the website was designed to help Alaskans prepare "to handle the challenges [of declining oil revenues] before we reach a crisis.”

What has puzzled us is why the Alaska Senate R's this last session seemed to run out of steam in their efforts further to cut the budget down to long term sustainable levels. We also have puzzled over the statement we have heard some make occasionally that deeper cuts in government spending would worsen the state's recession.

Then we ran across the following quote from the House website contained in the article. When reading this keep in mind that this was written while the R's controlled the House.  Keep in mind also that the Chair of the Special Committee was then-Rep. Anna Fairclough (now, MacKinnon).  MacKinnon is now
Senator MacKinnon and Co-Chair of the Finance Committee.

The quote is from a tab entitled "Why not just cut the budget" as a response to the, even then, painfully apparent coming fiscal crisis (we have added emphasis to parts that we think provide significant insight into the actions of the current Senate R's):
Why not just cut the budget? 
Alaska’s operating budget has been increasing at about 9% per year for the last decade and is expected to continue on this path. Even with tighter budget control, the budget will need to increase as population increases and to adjust for inflation just to maintain current levels of service. Increases in future obligations due to an aging population are a part of fiscal gap calculations and one reason why Alaska is not alone in facing future budget woes. 
While deep cuts to state services could help the plug the fiscal gap, they would hurt the economy and Alaska families. State government not only provides needed services and infrastructure, it also plays a significant role in the state’s economy, directly employing around 7% of working Alaskans (24,000 people in 2011) and generating even more jobs by providing grants and contracts to the non-profit and private sectors and by being a major purchaser of goods and services from Alaska businesses. Without state funding some of those jobs will disappear.

Often when people talk about cutting government spending they mean cutting out excess bureaucracy and paring back non-essential services. It will be important to find efficiencies and look for ways to trim waste, but there is a limit to what can be cut without cutting into basic services that many Alaskans rely on. Administration only accounts for 4% of the state operating budget. While there may be efficiencies that can be found, administration cannot be gutted since it includes core services like IT and telecommunications services, accounting and payroll that state agencies need to operate. 
In past years, the state has cut the capital budget when short-term deficits have occurred in years of low oil prices. Cutting the capital budget provides immediate savings but is a short-term fix that has its own negative impacts, such as higher future costs due to deferred maintenance on public buildings. Cuts to the capital budget also impact general contractors, engineers, and people working in the trades throughout Alaska who contract with the state to plan and build infrastructure projects. Maintaining public infrastructure, including roads, bridges, ferries and public health clinics is a core function of government that no one else is going to pay for if the state doesn’t do it. 
Budget cuts impact people differently. Cuts to education impact children and families, while cuts to the capital budget impact the Alaskans in the construction industry, and cuts to health and human services impact people with fewer resources. In one way or another, state spending improves the quality of life for all Alaskan. We are used to receiving high levels of service from our government. In a recent statewide telephone survey, Alaskans from all political parties chose maintaining state services over balancing the budget for nearly all state services.
As we went on in our 2012 post to discuss at length, the emphasis on maintaining jobs and a government role in the economy was troublesome.  As we said then in our commentary,
... the focus on the role of “government” as a source of jobs ... is something that one would ordinarily expect to hear from the far-left wing of the Democrat party, not a committee composed primarily of Alaska Republican House members. What happened to the usual — and economically sound — principle that government should leave the role of job creation — and more importantly, picking economic winners and losers — to the private sector, and limit taxes in order to permit the private sector to create those jobs and make those choices? This rhetoric sounds much more like that which justified the federal government’s recent economic stimulus packages than anything normally associated with “fiscal conservatives.”
 As we have entered an era where the Senate R's have now voted to cut the PFD rather than spending further, that philosophy is even more troublesome.

While solving one puzzle, however, finding the Senate R's past rationalization for their current actions creates another. 

If the "Special Committee" then -- and the Senate R's now -- are so concerned about the effect of their actions on "the economy and Alaska families," why is it they have chosen to tax (what some euphemistically refer to as "cut") the PFD as their primary means of keeping elevated government spending levels in place.

As ISER's undisputed economic analysis has made clear, taxing/cutting the PFD:
  • “Has the largest adverse impact on the economy [of all the new revenue options] per dollar of revenues raised,” at A-15;
  • “[W]ill likely increase the number of Alaskans below the poverty line by 12–15,000 (2% of Alaskans),” at 14.
In short, in order to avoid making "deep cuts to state services" because they "would hurt the economy and Alaska families," the Senate R's have chosen to implement the very option that ... hurts the economy ("has the largest adverse impact") and Alaska families ("by far the costliest measure for Alaska families") the most.

What the heck?

The portion of the website we covered in our 2012 commentary doesn't provide an insight into solving that puzzle. But when we have the time we will keep digging in the remainder to see if it provides any clues.

We doubt, as we have suggested elsewhere is the likely case, that we will find any smoking guns that say, "we have chosen to cut the PFD in order to protect the Top  20% from paying any significant share of the cost," but you never can tell.

Saturday, November 11, 2017

Notes from the Alaska Fiscal Cliff: Our Proposed Fiscal Solution

Yesterday we posted a comment on a presentation made Thursday of this week by David Teal, the head of the Alaska Legislature's Legislative Finance Division (LFD). 

The presentation discussed the projected status of the state's fiscal situation over the next eight years (FY 2019 - 2026) based on the most recent revenue and spending projections.  Teal's presentation is available here:

We expressed both surprise and disappointment at certain aspects of the numbers and analysis. Our comment is here:

The baseline

Nonetheless, in this piece we use Teal's presentation as a springboard to discuss our proposed solution to the state's fiscal situation. Using the same revenue and spending numbers, and format, as Teal used during LFD's presentation, our solution is summed up in the chart below.

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The numbers for the first two lines -- "Traditional Revenue" and "Expenses" -- are taken directly from LFD's presentation.  

The "Traditional Revenue" number is the projection of unrestricted general fund revenues by the relevant fiscal year taken from the Department of Revenue's Preliminary Fall 2017 Revenue Forecast,

The "Expenses" are LFD's representation of the projection of unrestricted general fund spending by the same year taken from the Office of Management and Budget's Ten Year Budget Forecast Relative to Preliminary Fall 2017 Revenue Projections,

For some reason the numbers used in LFD's presentation consistently are about $50 million higher per year than those in the OMB presentation. To make our analysis match up with LFD's, we nonetheless have used their numbers.

The "Initial Deficit" number is the simple difference between the "Traditional Revenue" and "Expenses" numbers for each year.  Adjusted for the $50 million added to the "Expenses" line in LFD's presentation, the deficit numbers used here correlate to the deficit numbers also shown for each year in the OMB Forecast.

The Initial Deficit forms the baseline of the state's fiscal situation.

The first part of the proposed solution:  Hammond 50/50

Starting with the baseline, we propose two steps in our effort to develop a balanced budget.

The first is to implement what we have referred to previously as the "Hammond 50/50 plan," an equal split of the earnings from the Permanent Fund between the PFD and government. See "Implementing Governor Hammond’s “50/50” Plan for the use of Permanent Fund earnings,"

With one adjustment, the "50/50 Government Revenue" number in the above spreadsheet is the "other half" of the annual Permanent Fund earnings stream calculated in the manner required for the Permanent Fund Dividend (AS 37.13.140), based on the levels of Statutory Net Income most recently projected by the Permanent Fund Corporation.  Alaska Permanent Fund Financial History & Projections as of September 30, 2017,

For purposes of this proposed solution we reduce the earnings stream by the amount of the current statutory inflation adjustment factor before dividing the remaining earnings stream equally (50/50) between the PFD and government.  We believe that the current statutory adjustment factor overcompensates for actual inflation, but recognize that some inflation adjustment is appropriate and so, utilize the current adjustment factor until a more accurate approach is developed.

The effect of making the adjustment before calculating the 50/50 split is to charge the inflation adjustment equally to the PFD and government shares of the Permanent Fund earnings stream, rather than take it entirely out of the government's share as historically has been the approach. We include that as part of our proposed solution because both future PFD and government revenue levels benefit from inflation proofing the Permanent Fund principal.

For those interested in that level of detail, our approach to calculating the "other half" used in the analysis is summed up below:

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The "Remaining Deficit" in the previous chart is the deficit remaining after applying the "other half" of the Permanent Fund earnings stream as government revenue.  

The second part of the proposed solution, if we need to go there:  A Flat Tax

At the projected spending levels used in LFD's analysis, while the adoption of the Hammond 50/50 approach reduces the deficit to lower, more manageable levels it does not eliminate the deficit entirely.

As a result, in order to balance the budget we calculate the "Flat Tax" required to raise the additional revenue needed to close the remaining deficit. The Flat Tax is equal to the amount of the deficit divided by $27 billion, roughly the amount of Adjusted Gross Income (AGI) currently received by Alaskans, adjusted to reflect the additional amount of AGI estimated to be received from Alaska sources by non-residents.  
See "ICYMI: Designing a Flat Tax,"

Under a flat tax, all Alaska families -- upper, middle and lower income -- would bear the costs of government proportionately.  No Alaskans would be required to bear a higher cost in order to subsidize the proportionate share of others.  As we have explained previously, there also are other significant benefits of the approach. See "Why a flat tax,"

Further adjustments

The level of flat tax required to close the remaining deficit is influenced significantly by two factors.  The first is the level of government spending ("Expenses"); the second is the level of the inflation adjustment used in the calculation of the "Hammond 50/50" revenue contribution.

The lower the level of government spending, the lower the deficit and as a result, the lower the level of flat tax required to offset the remaining deficit.

Similarly, the lower the level of the inflation adjustment, the higher the level of the "Hammond 50/50" revenue contribution, the lower the remaining deficit and, as a result, the lower the required level of flat tax.

Substantial effort has gone into -- and we assume, will continue to go into -- efforts to reduce the level of government spending.  Despite those efforts, however, both legislative bodies and the Governor essentially have concluded that there are limits to making further reductions in spending levels and that some source of "new revenues" is required.

To avoid becoming bogged down in that issue we have used the LFD's projection of future government spending levels in the above analysis.  Suffice it to say that the required flat tax levels will be lower if government spending levels are reduced further.

Some effort also has gone into -- and we assume, will continue to go into -- efforts to more accurately calculate the adjustment mechanism necessary to keep the Permanent Fund whole against inflation. 

To date, most efforts have centered around converting the basis for the calculation of the Permanent Fund earnings stream from Statutory Net Income to a Percent of Market Value (POMV) approach.  We are not necessarily opposed to that change if the POMV approach is proven to be more accurate than other inflation proofing approaches, but we have not been convinced yet that it is.

As a result, again to avoid becoming bogged down in that issue in this piece we have simply continued to use the inflation adjustment factor incorporated in the current statute at the future levels projected by the Permanent Fund Corporation.  
Suffice it to say that the required flat tax levels will be lower if the inflation adjustment is reduced.

One final adjustment also is appropriate.  

In the above analysis we have calculated the level of the flat tax, required to close the deficit remaining after the implementation of Hammond 50/50, on an annual basis.  In practice, we believe the level of tax should be averaged over an extended period based on periodic projections.  

Using the projections contained in the LFD analysis, the appropriate level of flat tax averaged over the eight year period, rounded to the nearest quarter percent, is 4.75%.