Legislature(2003 - 2004)
03/29/2004 09:10 AM House FIN
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* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
HOUSE FINANCE COMMITTEE
March 29, 2004
9:10 A.M.
TAPE HFC 04 - 69, Side A
TAPE HFC 04 - 69, Side B
CALL TO ORDER
Co-Chair Williams called the House Finance Committee meeting
to order at 9:10 A.M.
MEMBERS PRESENT
Representative John Harris, Co-Chair
Representative Bill Williams, Co-Chair
Representative Kevin Meyer, Vice-Chair
Representative Mike Chenault
Representative Hugh Fate
Representative Richard Foster
Representative Mike Hawker
Representative Reggie Joule
Representative Carl Moses
Representative Bill Stoltze
MEMBERS ABSENT
Representative Eric Croft
ALSO PRESENT
Senator Gene Therriault; Bob Bartholomew, Chief Operating
Officer, Alaska Permanent Fund Corporation, Department of
Revenue; Cheryl Frasca, Director, Division of Management &
Budget, Office of the Governor; Joe Balash, Staff, Senator
Gene Therriault
PRESENT VIA TELECONFERENCE
None
SUMMARY
HB 298 An Act relating to the distribution of
appropriations from the Alaska permanent fund
under art. IX, sec. 15(b), Constitution of the
State of Alaska, and making conforming amendments;
and providing for an effective date.
HB 298 was SCHEDULED but not HEARD.
HJR 9 Proposing amendments to the Constitution of the
State of Alaska relating to an appropriation limit
and a spending limit.
HJR 9 was SCHEDULED but not HEARD.
HJR 26 Proposing amendments to the Constitution of the
State of Alaska relating to and limiting
appropriations from and inflation proofing the
Alaska permanent fund by establishing a percent of
market value spending limit.
HJR 26 was HEARD and HELD in Committee.
HOUSE JOINT RESOLUTION NO. 26
Proposing amendments to the Constitution of the State
of Alaska relating to and limiting appropriations from
and inflation proofing the Alaska permanent fund by
establishing a percent of market value spending limit.
Co-Chair Harris MOVED to ADOPT Amendment #3, #23-LS1006\V,
Cook, 3/22/04. (Copy on File). Co-Chair Williams OBJECTED.
SENATOR GENE THERRIAULT spoke to Amendment #3. He addressed
concerns voiced by the public and members of the Legislature
regarding possible changes to the Permanent Fund and the
methodology used to determine that fund. The first issue is
one of protecting the principal of the fund. When
describing the Permanent Fund, it should be understood that
the money of the principal cannot be touched no matter how
much it is needed and the only way in which that could
change is through a vote by the people of Alaska. He
commented that the thought of moving toward a pure Percent
of Market Value (POMV) methodology would lift the bars that
protect the principal.
Senator Therriault indicated that Amendment #3 preserves the
idea of separate principal. There would remain the
protected principal of the Permanent Fund and would create a
sub account within the Earnings Reserve Account. The two
accounts would then be managed together except for the
allowable 5% draw. That amount could only be drawn out of
Earnings Reserve Account. If the allowed draw is only 5%,
there could be no access to the entire $4.5 billion dollars.
Senator Therriault mentioned that there are a number of
ideas floating around about how to manage it. The Trustees
suggested a statutory fund that would protect the principal
if the State moved into a series of down market years. He
doubted that the public would understood how that worked and
thought that the idea of the Percent of Market Value would
turn out to be an "easy criticism" for them. Senator
Therriault pointed out that the public wants to protect and
guarantee the dividend. He voiced support for making the
dividend multi generational and was resistant to a one-time
disbursement as proposed by Senator Mackie during a past
legislature.
Senator Therriault stressed that there should be a long-term
dividend acknowledged in the Constitution. The language
should indicate that from the 5% draw and out of the
earnings reserve, the money can be used for two things:
· Continuation of the dividend; and
· Use of the remaining funds for public education.
Senator Therriault noted that Co-Chair Harris had added
language to cover the costs of the fund's management. He
thought that would be a policy call. If there is access to
use of some of the earnings, the public will want to know
what those earning are being used for rather than assuming
purposes of general government. He pointed out that
everyone can think of something that they "loathe to hate".
The constitutional mandate that enjoys widespread support is
public education. That is the recommendation set forth by
Amendment #3 to address what the earnings are used for. The
term "public education" is broad and could cover K -
University, K - 12, or K - 12 operations and capital. The
language could be left broad and/or the numbers could be
flushed out or specific to the intent.
Senator Therriault maintained that the language of the
amendment addresses concerns indicated by the general
publics who will understand and appreciate a protected
principal. Currently, there is no constitutional protection
for the dividend and they want to know what the earnings
will be used for. That creates a balance for
constitutionally enshrining the dividend and preserving
latitude for future legislatures to establish how much can
be steered into dividend programs.
Senator Therriault summarized that if the amendment language
is adopted, it would provide an indication of what the
protected principal can be and the growth would be limited
to oil rents and royalties as they get deposited into the
principal. All the Permanent Fund earnings would be placed
into the Earnings Reserve Sub Account. The only growth
would be the amount deposited into the principal from rent
and royalties, which could easily be fixed by making an
allowance to periodically adjust the principal up. He
referenced Page 2 of the amendment, identifying
appropriations from the Earnings Reserve Account. That
language could be modified to state: "Except for periodic
transfers to the principal appropriations". The language
could specifically make a constitutional allowance for
periodic moving from the Earnings Reserve Account to the
protected principal by the Legislature.
Co-Chair Harris commented that there was nothing in the
proposed language that would prohibit the Legislature from
making an appropriation from the Earnings Reserve Account to
the principal protected by the Constitution. Senator
Therriault responded that is a question, as it would be
limited to only the money that comes off the overall account
and amounting to the 5%. It specifically has been
identified that the 5% can only be taken from the Earnings
Reserve Account. Appropriations from the Earnings Reserve
Account may be made only for certain purposes. The
Legislature has not provided them the latitude to make
appropriations over to the principal, however, the language
could easily be modified to specifically address that.
Co-Chair Harris recommended that a sub-floor could be added
to indicate that appropriations move back to the principal.
Senator Therriault suggested that by adding #4, there is
some question whether an appropriation or principal could
come only out of the 5% drawn. He did not think they would
want to do that. At this time, Legislative Legal is working
on an amendment to modify that language so that a transfer
from the Earnings Reserve Account could be made above and
beyond the 5%. He believed that would be easy to accomplish
and then they would need to address policy questions
regarding the veto power of a transfer.
Co-Chair Williams reminded Senator Therriault how difficult
it is to get a super majority. Senator Therriault
acknowledged that it can be difficult but if the 5% only
comes out of the Earnings Reserve Sub Account, it is
important to make sure that a healthy balance remains in
that account in case there is a down stock market, there
would still be sufficient funds. The Legislature could feel
pressure to make transfers to the principal; if the Governor
believes that too much has been transferred without having a
cushion, there might be a veto, which is a part of the check
and balance system.
Representative Fate voiced concern about using the Permanent
Fund for "rainy day" purposes. He warned consideration for
the replenishment of the Constitutional Budget Reserve
(CBR). He asked Senator Therriault how he proposed to
address these concerns if the above-mentioned items tied up
the Earnings Reserve Account. Representative Fate believed
this could exacerbate the problem over the years.
Senator Therriault responded that the issue of the CBR
repayment would be separate from the proposed consideration.
However, if covering the major costs for public education
was taken out of the Earnings Reserve Account, then general
fund dollars would not be spent. There could be a
possibility of a combination using earnings, taxes and/or
other revenue generating mechanisms providing general fund
dollars at the end of the fiscal year and swept back into
the CBR.
Representative Fate realized that those are expectations and
that he hoped that they would happen, however, present and
past experience indicate they have not yet come. He
suggested that the legislation will exacerbate the problems
and that the corpus expands and future problems will
continue. The worst-case scenario is "worrisome".
Vice Chair Meyer appreciated that the Percent of Market
Value concept automatically places funds into the principal
and asked how it would work under Amendment #3. Senator
Therriault explained that it would work in the same manner.
The protective principal and the Earnings Reserve Account
would be managed together. If there were a down market
without sufficient earnings, then a 5% draw would be taken,
without money drawn from the protected principal. The
intent is to have the entire fund managed, while maintaining
the fund and the 3% and then, the Earnings Reserve Account
would continue to grow. It would be good to have
flexibility to move some funds to the corpus while automatic
inflation proofing keeps happening. He concluded that a 3%
would be maintained so that inflation proofing would be
automatic.
Vice Chair Meyer understood that in the Percent of Market
Value concept as presented statewide. In the years when
the return is only 3%, it is highlighted that the payout
would continue to be at the 5% level. He hoped it could
reach 8%. Vice Chair Meyer asked if that would be enough
protection for the principal. He thought that the amendment
would provide a "new and different twist" for the voter's
comprehension.
Senator Therriault pointed out that in the pure POMV
concept, during a protracted down stock market, there could
be erosion of the principal. There does not need to be
erosion because the full 5% does not have to be taken. He
emphasized that the Legislature would be allowed to take up
to 5% and that the "suspicious public" might criticize that
action. The Legislature cannot assure them that the erosion
is not going to happen. If the language of the amendment is
adopted, it guarantees a protected principal, noting that
the Percent of Market Value methodology is still workable
but the State needs create a system in which they can
weather any down markets. Given Amendment #3, the general
public is assured that there will continue to be a protected
principal.
Representative Hawker pointed out that there are two
distinct issues being considered through the amendment:
· Consideration of the pure Percent of Market Value,
and
· Section #2, involving a dedication of what the
earnings might be used for.
Representative Hawker indicated that he would restrict his
thoughts to the percent of market value discussion. He
inquired if Senator Therriault had mentioned that the income
would be accounted for in the Earnings Reserve Account
rather than in the principal account. Senator Therriault
understood from working with Legislative Legal that once the
revenue is realized, it would then be accounted for in the
Earnings Reserve Sub Account. Representative Hawker was
confused if that meant only the realized earnings and not
those that result from increased valuation. Senator
Therriault referenced existing language on Page 1, Lines 12
& 13, "All income from the Permanent Fund shall be deposited
into the Earnings Reserve Account." He believed that should
define all income.
Representative Hawker pointed out that section indicates
that all income in the fund shall be deposited into the
Earnings Reserve Account as soon as it is received. The
intent is that it must be the realized earnings as opposed
to valuation changes. If that is the intention, then it is
assumed that there could be a decision to sell an investment
with the presumption of an absolutely sound economic
decision, the income not received and taken from the
principle and then placed into the Earnings Reserve Account.
He questioned if that was an intended division. Senator
Therriault did not know how the Trustees would interpret
that language and that it might have to be modified in order
to be made clearer.
Representative Hawker interjected that would be an important
distinction. Point #2 creates a strong desire on his part
to provide the greatest assurance that whatever changes made
would not compromise the ability of continuing the dividend.
Some earnings would be used for public services and that the
qualification of "received" would apply only to realized
earnings available for appropriation. The biggest problem
in the current structure is that the Earnings Reserve
Account would be within the Permanent Fund but subject to
appropriation. He thought that it would be possible for
someone with ulterior motives to manipulate investment
policy within the fund. Likewise, they would be able to
sell, which would change the amount in the Earnings Reserve
Account. Representative Hawker was troubled that action
might create in the constitutional mandate, two buckets of
money and subject to human manipulation. Representative
Hawker asked if there were sidebars that would protect the
State.
Senator Therriault understood that under the current system,
there could be no possible manipulation. There might be
pressure to sell in order to spike the earnings. If the
State moved to a Percent of Market Value system, he thought
that the stream of revenue off the account could spike the
earnings. He proposed that nothing could be changed if
something was sold, and would not change the value of the
fund with no motivation to change the revenue stream if it
was 5% of the total value. He believed that the system
proposed in Amendment #3 would lend itself less to public
pressure.
Representative Hawker summarized that the amendment would
place the Earnings Reserve into a separate bucket in the
Constitution and that it would be protected. The 5% factor
would still be based on aggregate value of the fund. He
asked if there would be a secondary constraint and if there
was no money in the Earnings Reserve Account, then would
there be no money left to withdraw from that fund. Senator
Therriault explained that possibility could only exist in
the first couple years, after the establishment of the Sub
Account. Thereafter, and if a healthy balance is
maintained, the State would be able to weather any kind of
bear market.
Representative Hawker thought that the probably of the State
having a disastrous market in the near future was slim. He
referenced Senator Therriault's definition of income. As
indicated, a transition into the new mechanism would take
place, making certain that there is income coming into the
Earnings Reserve Account to support a draw. He noted that
specific language indicates that all income from the
Permanent Fund shall be deposited into the Earnings Reserve
Account. He inquired how the amendment proposes to address
loss. Senator Therriault thought that the Earnings Reserve
Account could absorb the losses.
Representative Hawker commented that an earnings bucket
would hold all gains, losses, income and the sale of
investments. Any market valuation change would be accounted
for on the income side. He recommended that area of the
bill to place Senator Therriault's language that the net
income be accounted for in the Earnings Reserve Account,
without receipt qualification accounting for the value
change in the Earnings Reserve Account and principal. An
amount currently exists because deposits have been made to
the fund from the State's oil and gas wealth.
Co-Chair Williams noted it would be difficult to change the
Constitution. The State does not know what is going to
happen in the future. If the bill was passed as originally
proposed, no money could be taken out and a situation could
exist where there might be no money left to pay the
dividend. Senator Therriault asserted that the Legislature
would attempt to balance out the knowns and unknowns and
that except for the first couple years, the possibility of
moving into an immediate down market, there would be enough
money in the Earnings Reserve Account to assure that a 5%
stream will be available.
Co-Chair Williams spoke to the deposit made to the Earnings
Reserve Account and that by incorporating the proposed
amendment, the State could be starting over again with a
down market. Senator Therriault stated that in the future,
when the Legislature considers making a shift to protect the
principal, they might have to waive it. Making a shift
should require appropriation if it suffers a governor's
veto. If the amount moved over to the earnings principal
was large enough and the Earnings Reserve Account was small,
there could be a continued dividend and then the governor
could not veto it, removing the cushion. It would be
preserved. He acknowledged that there might be some
disagreement of how big a cushion should be continued. He
recommended that enough should be left to guarantee that the
5% would always exist. Senator Therriault stressed that it
is important to have a healthy Earnings Reserve Account.
Until the Earnings Reserve Account and the protected
principal are all managed together, then 5% would often be
the total. There should be more benefit to the public given
the method proposed in Amendment #3 as it would protect
against a down market. He thought that the Earnings Reserve
Account could be just as big as the protected principal and
that the Legislature could make a policy for shifting money
into either of the accounts.
Co-Chair Williams commented on placing money into the
principal every year. Senator Therriault stated that it
would be important to make sure that there are enough
earnings available in the Earnings Reserve Account to allow
for the 5% withdrawal, addressing transfers made to the
protected principal. He acknowledged the argument regarding
how much to leave in the reserve. There has always been
$100 million dollars remaining in that account. There has
always been a little pressure to make sure that enough
remained in that account for paying the next year's
dividend. Co-Chair Williams pointed out that there are
"politics involved".
Co-Chair Harris asked about the point made by Representative
Hawker regarding the income and to identify what qualifies
as income and loss.
BOB BARTHOLOMEW, CHIEF OPERATING OFFICER, ALASKA PERMANENT
FUND CORPORATION, DEPARTMENT OF REVENUE, explained that
currently as written, the constitutional amendment and the
proposed Amendment #3 would continue to do the accounting as
it is done at this time. There are two buckets for income
or earnings. The unrealized earnings, which result from an
asset going up in value after it is bought and defined in
the interpretation of the language remaining "Shall be
deposited as soon as it is received". He pointed out that
there is a solid record of what that means. When the assets
are sold, the realized income goes into the realized
earnings reserve. As written, the 5% available for
appropriation would come from the realized Earnings Reserve
Account.
TAPE HFC 04 - 69, Side B
Co-Chair Harris asked what would happen to the principal
and/or the loss. Mr. Bartholomew commented that they would
be treated just like the gains. The unrealized loss is
currently part of the principal allocation principle. When
a stock is sold for less than it is paid for, that becomes a
realized loss and goes into the Earnings Reserve Account.
Co-Chair Harris thought that was more difficult to
understand. A gain would be money going in. He asked if
money would be taken out of the Earnings Reserve Account and
deposited into the principal to make up the loss. Mr.
Bartholomew said no, but instead would handle it the same
manner it is currently is done. In the middle of a bear
market, there were many realized losses and they are
reflected in the Earnings Reserve Account. That account
goes up when there are gains and down when there is a loss.
The portions that are in principal, when it is an unrealized
loss, would stay if it was an unrealized loss. The existing
rules of the Permanent Fund were written twenty-five years
ago and are a little outdated. He proposed that the area
that should be discussed is treatment of gains and losses.
Co-Chair Harris questioned if there are losses from the
principal, would they be made up through the Earnings
Reserve Account. Mr. Bartholomew responded that, today, as
written and as described, the principal value would be
reduced until the investments were sold. If there are
losses in the stock market, the balance of the fund can fall
below the principal level, which has happened. That is a
rare situation. If stocks were sold, that would bring down
the balance of the Earnings Reverse Account.
Co-Chair Harris asked what would happen if the balance
wasn't large enough in a down market. He asked if that
would put the Board of Trustees in a situation where they
would have to take a loss. Mr. Bartholomew observed that
there are short to mid term risks, which they believe works
over the long run. If there is a large amount of unrealized
earnings and the realized earnings account has little income
paid out, the balance could be affected through the selling
of investments. Historically, the Board has deliberated on
that issue and taken action. The primary policy is to not
to make decisions based on what goes in and out of the
Earnings Reserve Account and the decisions to sell should be
based on the market.
Co-Chair Harris understood that the amendment attempts to
protect the principal in the Constitution. Mr. Bartholomew
pointed out that Section 1 of the amendment makes the
distinction between protecting the principal or moving to a
pure percentage of market value so that the 5% spending
limit provides statutory guardrails that prevent from over
spending when income is not available.
Representative Joule questioned if the amendment would
impact the sweep. Mr. Bartholomew responded that he had not
been involved in the process to determine the CBR sweep.
Senator Therriault did not think it would impact the sweep,
noting that the Court's have determined that the Permanent
Fund and the Earnings Reserve Account are not sweep able
accounts.
Representative Hawker questioned if the value of the
principal could erode over time. He inquired if those were
issues with the existing structure and if they could be
resolved through a pure POMV methodology. Mr. Bartholomew
noted that the original POMV and the amendment could achieve
the goals of the Trustees, which are, in good years, spend
only the sustainable yield of the Permanent Fund and
overtime, 5% of the total value. The amendment allows a
risk in the near term that there could be less than needed
for a full distribution during extended down markets in the
short term. He added that the issue of principal is a
public image concept. Near term good markets would reduce
the risk. Arcane accounting methods would be retained. The
Corporation knows that they can deal with continuation of
the current accounting methods.
Senator Therriault observed that the Trustees are advocating
for the long-term health of the asset. The downside of the
accounting method would be done away with through the pure
Percent of Market Value and if the pubic does not accept the
POMV method, nothing would change.
Representative Hawker acknowledged the controversy and felt
that the Committee should put forth the best policy call.
He indicated his concern with Amendment #3.
Co-Chair Williams added that the Committee has taken public
testimony on the Percent of Market Value for over a year and
that there has not yet been public testimony taken on the
proposed amendment. He expressed support for Version /U of
the legislation. He observed that the amendment, reflecting
the Senate version, could be discussed when the Senate bill
moves to the House floor. Senator Therriault emphasized
that the language in the Senate version has been debated and
that the House should not lose sight of what is possible
while striving for what is perfect.
Representative Joule voiced his support for Section 2 of
Amendment #3. He suggested that section could be added to
Version \U of the bill.
Co-Chair Williams stated that HJR 26 would be HELD in
Committee for further consideration.
ADJOURNMENT
The meeting was adjourned at 10:26 A.M.
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