State Attorney General Craig Richards unveiled Gov. Bill Walker’s new fiscal plan, in concept form, in a Oct. 28 briefing to legislators in Juneau. Essentially the plan calls for bulking up the Permanent Fund by transferring in other state savings accounts like the Constitutional Budget Reserve and also having certain oil revenues flow to the Fund instead of to the state general fund. The bulked-up Fund would then be managed like one of the large endowments that fund major universities and foundations.

In this proposal, income from the Permanent Fund would flow into the Fund’s earnings reserve account, as it does now. The Legislature would appropriate funds for the state budget from the earnings reserve based on a percentage-of-market-value formula, of POMV, typically a percent of the total market value of the Permanent Fund. The constitution prohibits spending from the principal of the Permanent Fund but the earnings reserve can be appropriated.

 

The underlying principle of this is that the volatility of oil revenues would mostly be absorbed in the Permanent Fund and not in the state general fund, as happens now. Presumably the Fund would be large enough to ride out these cycles of oil price dips, and spikes, along with the periodic cycles in financial markets. The formula that guides the annual withdrawal for state operations could be either whatever the POMV generates (a percent of the market value) or it could be a set amount per year, and perhaps adjusted to inflation (these features still being worked out). Other revenues, non-oil tax receipts and even certain oil revenues, from the oil corporate income tax and oil properties tax, would still flow directly to the general fund.

 

This approach, if put into effect immediately, wouldn’t close the $3 billion budget gap in FY 2017 but it would reduce to about $500 million, which is close enough to be closed by other measures, such as continued budget cuts and new taxes.

 

What about the Permanent Fund dividend? The plan would continue the dividends but would fund them differently. Instead of being funded by a percentage of earnings of the fund (using a five-year trailing average) the dividends would be funded directly from oil royalties, or rather half of state royalty income net of the portion (25 percent) that is mandated, by the Constitution, to go the Permanent Fund. Thus, the dividend gives Alaska citizens a direct stake in the state’s oil industry rather than the indirect stake through the earnings of the Permanent Fund, the current system. Under this system the dividends would reflect the volatility of oil revenues, but this substitutes one volatility for another because dividends now reflect the uncertainty of financial markets.

 

There are a lot of things still to be worked out on the dividend side of this. If this system were to be put into effect immediately the dividend in 2016 would be about $1,000 or about half of what it was in 2015, Attorney General Craig Richards told legislators in a briefing Oct. 28. Features that could be added might include a five-year averaging to smooth out abrupt falls and rises, as is currently used with the dividend calculation, and perhaps a minimum dividend, say $1,000.

 

The concept that Gov. Walker and his administration are working with is a big pill to swallow for the Legislature and public on short notice. There’s a lot to understand, but the concept is on the table now, so it’s something for lawmakers to digest between now and the 2016 session. So far no one has outright knocked the concept, which is good.

 

It will have to withstand some tough tests. The first is the technical aspect, and how it would work. More important, will it work, and what are the potential shortcomings? Second it will have to meet political tests on the legislative level, amidst a climate that is polarized and a leadership not very friendly to the governor. Third, the proposal will have to meet political tests that will pivot on whether a constitutional amendment is required or not.

 

Attorney General Richards in his presentation said a statutory construction with a POMV (taken from the earnings reserve) is possible, but also said implementation a pure and Sovereign Wealth concept, which pools the state’s wealth now in various accounts with exception of pension funds, would likely require a constitutional amendment. If the latter is the case the method is likely dead on arrival. That’s because a pure Sovereign Wealth plan is complex, perhaps too much so for the public to absorb. The Attorney General described a modified Sovereign Wealth and POMV plan that could be done by statute, avoiding a constitutional amendment, but it still includes limiting the dividend, which raises political risks.

 

We would advise not taking this plan to a public vote, as was done with a previous, similar, proposal (and with disastrous results). An old rule in resolving governmental fiscal crises, at least on the state level, is that you never ask the public if it wants to pay a tax (and limiting the dividend is a form of taxation) because the only answer you will get is a loud “No!” However, this isn’t to say that the dividend can’t be limited by statute, as legislators can now do, but doing so is politically risky.

 

We note that the politics of local governments are a little different because the relationship between municipal government, the taxes people pay, and services, are more direct. In our state government, oil revenues pay for virtually all services.

 

Other comments we’re hearing, on the policy issues:

 

Others we have consulted, who are familiar with politics, state government and the Permanent Fund, have some deeper criticisms of policy aspects of the plan. There are three that ring most loudly:

 

• The plan rests on a yet-to-be revealed, or perhaps developed, mechanism, or model, that would guide the amount that would be paid each year from the Earnings Reserve to the state general fund. Attorney General Richards described one approach, a straightforward POMV of the combined assets’ market value in the Permanent Fund and earnings reserve, but said there could be problems with this because money can legally be taken only from the earnings reserve and if there is a string of poor financial years the reserve account could be exhausted, putting the state in a bind.

 

Richards seemed to say more work is being done on the payout model to resolve these issues, but whatever is arrived at will need careful scrutiny. The concern some people have is that a formula will be arrived at that is complex, difficult to understand (for the public) and therefore less-than-transparent. This will raise suspicions that the formula, or model, could be manipulated, for example to generate more revenue in a given year. This has happened before when legislators chose to interpret state oil economists’ estimates of oil revenues in their own ways so as to be able to fund more capital projects.

 

Another area of concern is more philosophical, the de-linking of the PFD dividend from financial performance of the Fund, by switching the dividends’ fund source to a portion of oil royalties. De-linking the dividend from the Fund goes against former Gov. Jay Hammond’s fundamental premise of the dividend as a safeguard for the Fund, preventing the Legislature from devising ways to raid the fund and discouraging the trustees from making unwise investments.

 

One final concern is that this plan of a bulked-up Permanent Fund will require a much more careful and professional approach to governance. Basically, what will be needed is a much higher caliber of people on the Board of Trustees, not just state commissioners appointed by the governor and citizen appointees who are more-or-less friends of the governor who appoints them. The governance of large endowments elsewhere in the country should be looked to as a guide.

 

Fundamentally, while there’s a lot of good to this plan we also can’t help get this feeling that this is really a way for the governor and the Legislature to get off the hook in squarely facing up to the eventual need for citizen taxes. This plan will take at least a year to debate, which gets us through the 2016 elections, and basically kicks the can down the road a bit.

 

We cannot help but point out that elsewhere broad citizen-based taxes are a major force in moderating a public budget. Walker’s proposal appears to end-run the necessity of adopting a major citizen tax, or at least facing up to it immediately.