After looking at the mechanics of Gov. Bill Walker’s Permanent Fund Protection Act, the House Finance Committee heard testimony Friday on the plan’s modeling and the impact various actions will have on Permanent Fund dividends (PFDs).
The Permanent Fund Protection Act (PFPA), filed in the House as HB 61, seeks to take 5.25 percent of the average value of the Permanent Fund over five years and use that money to pay for government expenses.
Department of Revenue (DOR) Commissioner Randall Hoffbeck said a lot of effort has been put into finding the “sweet spot” for this percent-of-market-value (POMV) draw from the Permanent Fund earnings reserve, the storage account for the Fund’s realized investment earnings from which PFDs are paid.
DOR personnel have asked themselves, “How much can we draw without damaging the corpus of the Fund?” Hoffbeck said in Friday’s hearing.
In Fiscal Year 2018, PFPA is estimated to generate $2.4 billion. After $700 million is deducted to pay a $1,000 PFD, $1.7 billion would be left to partially address a $3 billion deficit.
Walker is also requesting that a $2.4 billion draw be made in FY 2017 to pay back savings used for the current year’s budget.
DOR’s probabilistic modeling assumes an inflation rate of 2.25 percent. Future budgets would only grow with inflation, beginning in FY 2020.
If the legislature implements PFPA as written without adopting any new taxes or making budget cuts, the real value (the value adjusted for inflation) of the Permanent Fund will decrease from $53 billion to $45 billion by FY 2041.
The decrease in value is because the State’s main savings account, the Constitutional Budget Reserve (CBR), would be exhausted in FY 2028, causing the legislature to make unplanned draws from the earnings reserve in addition to the POMV draw.
Consequently, the failure rate of the earnings reserve — the probability that it cannot serve its functions, including PFD payouts — rises dramatically. It hits 30 percent in FY 2036 and reaches 45 percent in FY 2041.
“When you start to deplete your earnings reserve, you can actually get to a point where you start to decrease your dividend, as well, because the dividend can never be more than half of the earnings reserve balance,” explained Hoffbeck. “When the earnings reserve fails, so does the dividend.”
“It is not durable, it is not sustainable, as a standalone solution,” Hoffbeck said of PFPA. “It needs to be part of a broader plan.”
If the legislature were to adopt PFPA and close the remainder of the deficit with cuts and/or taxes, the real value of the Permanent Fund would grow to $58 billion in FY 2041. The failure rate of the earnings reserve would be about one percent.
Choosing to begin the POMV draw next year, rather than repay the FY 2017 draw from savings, would result in a real Fund value of $61 billion in FY 2041 and a negligible earnings reserve failure rate.
“There’s very little difference in durability with or without the FY ’17 draw,” Hoffbeck testified. “The Fund is slightly more durable. The Fund grows slightly larger. A dividend is slightly larger under an FY ’18 start date.”
The big loser under all Hoffbeck’s scenarios is the PFD.
PFPA creates a new formula paying PFDs from a mix of petroleum royalties and 20 percent of the POMV payout.
Tying PFDs directly to petroleum royalties means that PFDs will decrease with the forecast decline in oil production.
With passage of PFPA and a plan to close the fiscal gap, the real value of PFDs would decrease to $830 in FY 2041. If the legislature only passes PFPA without closing the gap, the real value of PFDs drops to $727 in FY 2041.
Hoffbeck noted that there will be no PFD payout in 2031 if the legislature follows the status quo.
Rep. Tammie Wilson (R-North Pole) said the phrases “status quo” and “business as usual” are disrespectful. The legislature has cut billions from the budget in the last four years and passed Medicaid and criminal justice reform measures last year for further savings.
House Finance Vice-chair Les Gara (D-Anchorage) pointed out that despite those actions, the State has burned through over $6 billion in savings over the last two years.
“By status quo, I don’t mean that the legislature hasn’t done anything,” Hoffbeck explained. “What I’m saying is that — starting from today, with today’s budget and today’s revenues that we have — if those don’t change and we just continue to spend CBR to fill the gap, what does that do to the Permanent Fund earnings over time?”
Without a plan, the CBR will be empty in FY 2019, and the State will have to begin pulling money from the earnings reserve.
Draws from the earnings reserve without a fiscal plan or PFPA cause the failure rate to hit 50 percent in FY 2024 and 90 percent in 2029. PFD payouts stay above $2,000 in the short term, but drop below $1,000 in 2027 before disappearing in 2031.
The Permanent Fund’s real value drops below $40 billion ten years later.
“You would see significant degradation in the value of the Fund under the status quo,” Hoffbeck said.
The Permanent Fund will fail over time under this scenario, he warned.
Left unsaid was that when the CBR and the Permanent Fund earnings reserve can no longer fill deficits, the State will have to amend the Alaska Constitution to access the principal of the Permanent Fund.
House Finance is scheduled to hear from Legislative Finance Director David Teal on Monday. Teal will provide “a framework for analyzing fiscal plans.”