160108-gunnar knapp-an introduction to alaska fiscal facts and choices-january 8, 2015 02

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An Introduction toAlaska Fiscal Facts and Choices

Gunnar KnappDirector and Professor of Economics

Institute of Social and Economic ResearchUniversity of Alaska [email protected]

January 8, 2016

ISER publications and presentations are solely the work of individual authors and should beattributed to them, not to ISER, the University of Alaska Anchorage, or the research sponsors.

mailto:[email protected]

Alaska’s faces an extremely serious fiscal challenge.We are spending more than twice as much as our revenues.We are paying for the deficit by drawing down our savings.

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We can’t continue to run huge deficits like this year’s.We don’t have enough savings.

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In the next few years,we will have to close the funding gap

between our spending and our revenues.

We will have to make big changesin what we spend or how we pay for it—or both.

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From 2005 to 2014, oil revenues

averaged 90% ofAlaska’s

“unrestricted general fund revenues”

(which pay for state

government).

Alaska has been extremely dependent onoil revenues to fund state government.

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Our state revenues are extremely sensitive to oil prices—particularly at prices above $80/barrel.

Oil prices have fallen drastically over the past year and a half—and are continuing to fall.

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The price was $34/barrel on

January 5

ProjectedHistorical

$7.8 billion drop in oil revenues from 2012

to 2016(88% drop)

Mostly because of the fall in oil prices, our oil revenues have fallen drastically.Falling oil production and higher costs and credits have also played a role.

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From 2005 to 2012 oil prices and revenues

rose dramatically

In just four years,most of the money we had been

using to pay for state governmentevaporated.

It’s gone.

That’s why we have a big problem.

Won’t oil prices go back up and save us?

• It happened in the early 2000s when we faced a similar fiscal challenge.• It could happen again.

• But it probably won’t.– There is a glut of oil on world markets

• Most oil market analysts think prices won’t rebound above $70-$90/barrel, because– So much oil production is profitable at those prices– Growth in world oil demand is slowing

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Hoping that oil prices rise is not a realisticor responsible solution to our fiscal challenge.

Even if oil prices rise, our oil revenues will declineas oil production falls.

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From 2005 to 2012, even though spending was rising, we ran big General Fund surpluses. Since 2013 we

have been running big General Fund deficits.

ProjectedHistorical 12

We used the surpluses prior to 2012 to build up our savings reserve.Since 2013 we have been rapidly drawing down our reserves.

Continued deficits of this year’s level could drain our reserves in 2 years.

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ProjectedHistorical

This year’s (FY16) projected deficit is huge.

FY16 unrestricted general fund spending

$5.2 billion

$3.6 billion(69% of

spending)

$1.6 billion

Projected deficit

Projected revenues

$7,100per Alaskan

$4,900per Alaskan

$2,200per Alaskan “Per Alaskan”

figures are based on 2014 Alaska

population estimate of 735,601.

How we are spending $5.2 billion in FY16

1,247 (96%) isK-12 formula

641 (55%) isMedicaid formula

Trends in General Fund spending, FY07-FY16

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The Permanent Fund is worth more than $50 billion.Most of the value is in the principal, which we can’t spend.

We can only spend the “realized earnings” in the earnings reserve,which are currently about $7 billion.

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The Permanent Fund earns billions of dollars in most years,which go into the earnings reserve.

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Every year, we take money out of the earnings reserve to pay fordividends and inflation proofing.

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In most recent years the Permanent Fund has earned more than we have used for dividends and inflation proofing—so we have been retaining some earnings

and the earnings reserve has been growing.

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Like oil revenues, Permanent Fund earnings are highly variable—but they have been growing as the Fund grows. For the past two years they have

been more than our oil revenues.

ProjectedHistorical

HOW WILL WE FILL THE FUNDING GAP?

Our only significant and practical options are some combination of:

Spending cutsNew revenues

Using Permanent Fund earnings

There are no easy choices.

The funding gap is so large thatwe will probably need to use all of these options.

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The challenge with spending cuts is figuring out what to cut that isn’t mandated, essential or “penny-wise but pound-foolish.”

Very little capital

spending is left to cut

It would be very difficult to

cut debt & retirement spending

Cutting oil tax credits could affect future production

and revenues

Most cuts would have to come from state agencies—including education & health

There are many potential options for new state revenues—but none would be enough to close the funding gap.

Alaskans pay much lower broad-based state taxesthan residents of any other state.

Alaska 25

Using Permanent Fund earnings would require some combination of:- Reducing Permanent Fund dividends

- Reducing inflation proofing- Adding less to the Earnings Reserve- Drawing down the Earnings Reserve

How would different options for closing the fiscal gap affectAlaska’s economy and Alaskans?

Option Effect on the economy Who would be most affected

Cutting spending

Fewer government jobs & income

Fewer contractor jobs & income

Multiplier effects of lower spending by government & contractor employees

Government employees

Contractor employees

Trade and service industry businesses & employees

Beneficiaries of government services that are cut


Option Effect on the economy Who would be most affectedIncome taxesSales taxes

Less personal income

Multiplier effects of lower spending by households

Richer families (income taxes)All families (sales taxes)


Resource industry taxes

Less business incomeFewer resource industry jobs

Multiplier effects of lower spending by resource industry businesses & households

Resource industry businesses Resource industry families



Option Effect on the economy Who would be most affected

Cutting dividends

Less personal income

Multiplier effects of lower spending by households

All families

(The relative effects would be greatest for poor families & large families)



Option Effect on the economy

Who would be most affected

Cutting Permanent Fund inflation proofing

Adding less to or drawing down the Permanent Fund earnings reserve

No immediate effect

Slower Permanent Fund growth

Lower future Permanent Fund earnings

Future Alaskans

WHEN WILL WE FILL THE FUNDING GAP?

The more gradually we adjust, the smaller the immediate direct effects on the economy.

But the longer we delay:

The bigger the future direct effects on the economy.The greater the risk of forced drastic adjustments.

The greater the risk to investor confidenceThe greater the risk to our credit rating

The lower our future investment earningsThe less savings we leave for future generations

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Our income

- What we add to our savings

+ What we take out of our savings

= What we can spend

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Over any period of time what we can spend is constrained by our income and

what we add to or take out of our savings.

Four key choices that we facein thinking about how to close the funding gap

Our income Oil incomePermanent Fund earningsOther current revenuesNew tax revenues


Royalty deposits to the PF principalInflation proofing deposits to the PF principalWhat we add to the PF earnings reserveWhat we add to the CBRF


What we take out of the PF earnings reserveWhat we take out of the CBRF

= What we can spend

Government spendingDividend spending

Any choice that we make about anything affecting our revenues, spending or what we add to or take out of our

savings affects our options for all our other choices.

1. What should we assume about oil prices, oil production, and Permanent Fund rates of return?

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Oil prices & oil production affect our

oil income.Our income Oil incomePermanent Fund earningsOther current revenuesNew tax revenues

- What we add to our

savings


+ What we take out of our

savings


= What we can spend


Permanent Fund rates of return affect our Permanent Fund

earnings.

2. How much do we want to tax ourselves or our industries?

Our income

Oil income

Permanent Fund earnings

Other current revenues

New tax revenues





= Our spending


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The more we raise from new taxes the more we

can spend.

3. How much do we wish to add to or take out of our savings?

Our income

Oil income



New tax revenues





= Our spending


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How much we add to or take out of our savings affects what how much we can earn and spend

in the future.

The less we spend now, the more we can spend

in the future—and vice versa.

4. How much do we want to spend on government and dividends?

Our income

Oil income



New tax revenues





= Our spending


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The more we spend for dividends, the less we can

spend for government—and vice versa.

Our options and choices for what we can spendare fundamentally constrained by

our future oil revenues and permanent fund earnings.

They are also uncertain because we don’t know whatoil prices and permanent fund rates of return.

The following graphs illustrate what the rangeof what we could spend might be

for different combinations of assumptions.

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What our current oil and other revenues would be at different oil prices

What the Permanent Fund would earn at different rates of return

These projections assume that all earnings of the Permanent Fund are spent except those neededto allow the fund to grow at the rate of inflation, so that its real value stays the same.

How much can we spend per year for government and dividends combined?

from our current revenue sources (oil revenues, non-oil revenues, and PF investment earnings)without reducing the inflation adjusted value of the Permanent Fund over the next 10 years?

5% 6% 7% 8% 9%$40 2,900 3,450 4,000 4,600 5,150$50 3,200 3,750 4,300 4,900 5,450$60 3,600 4,200 4,750 5,300 5,900$70 3,900 4,450 5,050 5,600 6,200$80 4,250 4,800 5,350 5,950 6,500

DOR forecast 3,950 4,500 5,100 5,650 6,200

Average Permanent Fund Rate of Return

Price of oil

It depends on the price of oil and the Permanent Fund rate of return.

If we raise new revenues we could spend more.

If we want the Permanent Fund to growwe have to raise new revenues or spend less.

How much can we spend per year for government?

from our current revenue sources (oil revenues, non-oil revenues, and PF investment earnings)without reducing the inflation adjusted value of the Permanent Fund over the next 10 years?

It depends on the price of oil and the Permanent Fund rate of returnand on what we spend for dividends.

If we keep dividend spending at last year’s total ($1.4B) we could spend:

5% 6% 7% 8% 9%$40 1,500 2,050 2,600 3,200 3,750$50 1,800 2,350 2,900 3,500 4,050$60 2,200 2,800 3,350 3,900 4,500$70 2,500 3,050 3,650 4,200 4,800$80 2,850 3,400 3,950 4,550 5,100

DOR forecast 2,550 3,100 3,700 4,250 4,800

Price of oil

Average Permanent Fund Rate of Return

If we raise new revenues we could spend more.If we spent less for dividends we could spend more.

Our fiscal options aren’t so bad compared with most other states.

• Most other states:– Don’t have any oil revenues– Don’t have any Permanent Fund earnings

• That’s why most other states:– Spend much less for government– Have income taxes and/or sales taxes– Don’t pay dividends

• Our basic fiscal options are to become more like other states:– Spend less for government– Tax ourselves more– Pay smaller dividends

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Two potential approaches to using Permanent Fund earningsto fund state government

Approach History/backgroundSenate Bill 114 Introduced during the 2015

legislative session

Walker administration’s “sovereign wealth fund” proposal

Proposal released by Walker administration Fall 2015

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Major Alaska state revenues and spending flows, FY16

GeneralFund

Oilroyalties

Governmentspending

Permanent Fundrealized earnings

ConstitutionalBudgetReserve

Fund

Permanent

Fundprincipal

PermanentFund

earningsreserve

Non-OilRevenue

s

Oiltaxes

Dividendspendin

g

Arrow sizes are proportional

to FY16 revenue &

spending flows

SB 114 approach: “Swap” funding for dividends and government

GeneralFund

Oilroyalties

Governmentspending



Fund

Permanent

Fundprincipal

PermanentFund

earningsreserve

Non-OilRevenue

s

Oiltaxes

Dividendspendin

g

Dividends would be paid from 75% of oil royalties

A payout would go from Permanent Fund earnings to the General Fund based on 5% of average market value

over the past 5 years.

Sovereign wealth fund approach: Almost all oil revenues would go to the Permanent Fund, which would make a fixed payout to the General Fund.

GeneralFund

Oilroyalties

Governmentspending



Fund

PermanentFund

Non-OilRevenue

s

Oiltaxes

Dividendspendin

g

Dividends would be paid from 50% of oil royalties

A fixed annual payout would go from the Permanent Fund

earnings reserve to the General Fund

(estimated @ $3.2 B)

160108-gunnar knapp-an introduction to alaska fiscal facts and choices-january 8, 2015 02

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