On Thursday, legislators held the first hearing on Gov. Bill Walker’s Permanent Fund Protection Act, a plan to sustainably use investment earnings to partially fund government.
The State is facing another $3 billion budget deficit next year. A draw from savings to fill that gap would leave insufficient savings to fill the deficit in Fiscal Year 2019.
“This will be the last budget year where that could be filled using just simply savings, and then we would be standing with our toes totally off the cliff looking at what do we do next,” Department of Revenue (DOR) Commissioner Randall Hoffbeck testified at a House Finance hearing Thursday. “We’ve run out of time with the status quo.”
Oil production is forecast to decline while prices hover around $55 or $60 per barrel.
“We don’t really see a scenario where that rebounds very heavily, so we’re looking at a long-term structural deficit that needs to be resolved,” Hoffbeck said.
“We need another significant source of revenue so that we don’t have a persistent deficit and we don’t continue to draw down on our savings, on our budget reserves,” he continued. “The Permanent Fund is our largest asset at this point in time and will be going forward.”
HB 61, the “Permanent Fund Protection Act” (PFPA), uses a percent-of-market-value (POMV) approach, drawing 5.25 percent of the average value of the Permanent Fund over five years from the Earnings Reserve Account. 5.25 percent should be less than the rate of return on the Permanent Fund’s investments, allowing the Fund to continue to grow.
“To be sustainable in a long-term solution, any plan has to maintain or grow the real value of the Permanent Fund,” Hoffbeck explained. The plan must also provide a formula for sustaining Permanent Fund dividends (PFDs).
In FY 2018, the POMV draw is estimated to produce $2.5 billion. $700 million of that would go toward a $1,000 PFD. Future PFDs under the formula are expected to remain around $1,000.
Walker reintroduced PFPA in a form similar to that which left the Senate Finance Committee last year and eventually passed the full Senate, 14-5.
The bill died in the House Finance Committee, despite an effort by members to increase the PFD to $1,500 while further limiting the POMV draw. The 5-6 House Finance vote split causes and political parties.
PFPA was back before House Finance on Groundhog Day.
Of those who voted against PFPA last year, Representatives David Guttenberg (D-Fairbanks), Scott Kawasaki (D-Fairbanks), Tammie Wilson (R-North Pole), and Lance Pruitt (R-Anchorage) remain on the 11-member committee. Two “yes” votes remain, Vice-chair Les Gara (D-Anchorage) and Rep. Steve Thompson (R-Fairbanks), establishing a tough baseline for a pro-PFPA whip.
For skeptics, Hoffbeck noted that if all the other proposals being floated — a motor fuel tax, a broad-based tax, $750 million in cuts — were adopted, they would only cover $1.6 billion of the deficit.
Without a plan this year to close the deficit, the State will face backlash from credit rating agencies.
“The private sector has made it very clear: they want to see a complete fiscal plan in order to start making significant investments in the State again. The Permanent Fund is really the only way that you can get to that final solution,” Hoffbeck said, despite previously being cautioned by legislators against use of the phrase “final solution.”
“There’s not enough money in cuts and other revenues to get us to that solution without using earnings of the Permanent Fund,” Hoffbeck insisted.
Walker Administration Trying to “Maximize the Value” of Permanent Fund
Hoffbeck emphasized that rules are necessary in any plan to protect the Permanent Fund.
“Ad hoc, unplanned withdrawals from the fund pose a danger of allowing short-term priorities to overwhelm concern for the long-term health of the fund,” DOR wrote in a white paper. “A series of rules that define how much goes into and comes out of the fund (and when) provide a framework for measured and sustainable reliance on the fund. This type of framework ensures that the permanent fund remains permanent, providing for Alaskans well into the future.”
Hoffbeck said a 5.25 percent POMV draw was chosen to use the full potential of the Fund.
But several House Finance members were concerned that 5.25 percent exceeds the five percent real return goal adopted by the Alaska Permanent Fund Corporation Board of Trustees.
Hoffbeck demonstrated in a presentation that while the draw is 5.25 percent of the average value of the Fund over five years, as long as the Fund continues to grow, the effective POMV will always be less than five percent of the value of the most recent year.
“If we leave money on the table from the Permanent Fund earnings by being too cautious in the Plan, we really make the hard choices to fill the rest of the gap even harder,” he said.
What happens if there are several consecutive years of poor investment returns, asked Gara.
“To create a structure to deal with that would not maximize the value of the Fund,” Hoffbeck responded, adding that years like 2009 tend to be anomalies.
To build the Permanent Fund, any amount in the earnings reserve in excess of four times the POMV draw will be deposited in the constitutionally-protected Permanent Fund corpus.
The bill requires a review of the Plan every three years to allow any governor at least one chance to be involved in reconsideration of the Plan’s assumptions.
Revenue Limit Versus Spending Limit
PFPA also includes a limit to the POMV draw designed to prevent “hyper-inflation” of government spending. Otherwise, Hoffbeck said, the draw would simply be stacked on top of other State revenue.
For every dollar of petroleum revenue that exceeds $1.2 billion, the POMV draw is reduced by a dollar.
The idea to shut off the POMV draw as other revenue increases came from Senate State Affairs last year, something Hoffbeck called “the hearing process at its best.”
It effectively caps revenue at $3.8 billion when oil prices reach $70 per barrel. When oil hits $105, the POMV draw is reduced to zero.
Yet the Fall Revenue Sources Book produced by DOR does not anticipate oil prices to hit $70 in nominal dollars until FY 2022.
For reference, the enacted FY 2017 budget and the proposed FY 2018 budget are $4.3 billion, $500 million more than the effective revenue cap in PFPA.
“At some point, if we ever get to $70 a barrel again, that’s when we don’t get to use the extra State revenue,” Gara lamented. “I think that makes us pretend that we don’t have a billion-dollar deferred maintenance obligation. It makes us pretend that we’re not $30 million behind school funding from where we were just two years ago.”
“This does not allow for a capital program. It doesn’t allow for many other things. Frankly, that’s going to have to be generated with other revenues,” Hoffbeck acknowledged.
Acceptance of new revenues was mixed among House minority members during a press conference Thursday.
House Minority Whip Mike Chenault (R-Nikiski) said he expects a blend of budget cuts and new taxes to address the deficit, but Rep. David Eastman (R-Wasilla) said the only tax introduced so far hits Mat-Su commuters hard.
“By tripling the fuel tax,” Eastman said, “what you’re doing is you are telling people, ‘You have the option of not consuming fuel and not going to work,’ or making it more expensive for them to do so. In our current economy, I don’t think we want to discourage folks from working. So I would be opposed to that.”
While the PFPA limits revenue through the cap on the POMV draw, Hoffbeck said the administration removed a spending cap that was inserted in last year’s version of the bill. He said a conversation about spending should be a separate consideration.
There are four bills or proposed constitutional amendments introduced by the current legislature that would limit spending, and more are likely.
The House majority has indicated they are satisfied with the appropriation limit that already exists in Article IX section 16 of the Alaska Constitution.
“To say that that spending limit is appropriate or is sufficient I think is plainly false because if you were to apply that spending limit today, we would have a $10 billion budget,” Eastman said in response. “The voters in my district want us to commit to limiting spending, and if the House majority is not willing to do that, then I think that’s the indication to the rest of us that this is going to be a slow progress.”
“This is the year,” Pruitt said of reaching a fiscal solution. “We’re ready to be part of this discussion.”
But, Pruitt added,
If you’re just going to shut down and say that some sort of spending cap is not allowed to be a part of the conversation, we’re going to push back. I’m going to push back against that. We can’t have uncontrolled spending. We don’t have the social license with the public out there to take money from the Permanent Fund — whether it’s taxes, any of that stuff — until we prove to them that we can spend the money and use it wisely. They’re scared to death of us getting ahold of the Permanent Fund without some sort of controls in our ability to spend it.
Mindful of those concerns, Hoffbeck later told House Finance, “We tried to leave as much of the structure that protected the Fund under the status quo in place to give some comfort that the Fund would be protected under the new Plan.”
Hoffbeck will be back in front of House Finance Friday with some modeling on the PFPA and to show what PFD amounts would look like in a few years.