Legislature(2015 - 2016)HOUSE FINANCE 519
02/15/2016 01:30 PM House FINANCE
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| Audio | Topic |
|---|---|
| Start | |
| HB245 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| += | HB 245 | TELECONFERENCED | |
| + | TELECONFERENCED |
HOUSE FINANCE COMMITTEE
February 15, 2016
1:33 p.m.
1:33:19 PM
CALL TO ORDER
Co-Chair Thompson called the House Finance Committee
meeting to order at 1:33 p.m.
MEMBERS PRESENT
Representative Mark Neuman, Co-Chair
Representative Steve Thompson, Co-Chair
Representative Dan Saddler, Vice-Chair
Representative Bryce Edgmon
Representative Les Gara
Representative Lynn Gattis
Representative David Guttenberg
Representative Cathy Munoz
Representative Lance Pruitt
Representative Tammie Wilson
MEMBERS ABSENT
Representative Scott Kawasaki
ALSO PRESENT
Randall Hoffbeck, Commissioner, Department of Revenue;
Craig Richards, Attorney General, Department of Law;
Representative Cathy Munoz; Representative Mike Chenault.
SUMMARY
HB 245 PERM. FUND:DEPOSITS;DIVIDEND;EARNINGS
HB 245 was HEARD and HELD in committee for
further consideration.
Co-Chair Thompson reviewed the meeting for the day.
HOUSE BILL NO. 245
"An Act relating to the Alaska Permanent Fund;
relating to appropriations to the dividend fund;
relating to income of the Alaska Permanent Fund;
relating to the earnings reserve account; relating to
the Alaska Permanent Fund dividend; making conforming
amendments; and providing for an effective date."
1:34:08 PM
RANDALL HOFFBECK, COMMISSIONER, DEPARTMENT OF REVENUE,
indicated he would spend just a few minutes recapping what
was covered in the previous meeting up to Slide 11. He
relayed that the Alaska Permanent Fund Protection Act
(APFPA) was one of three major components of the New
Sustainable Alaska Plan, the governor's plan to reach a
sustainable long-term budget and revenue stream for the
State of Alaska. The Alaska Permanent Fund Protection Act
only dealt with one piece having to do with how the state
used its Permanent Fund (PF) earnings. It also contained a
portion which restructured the dividend.
Vice-Chair Saddler asked if there was an old sustainable
Alaska plan. Commissioner Hoffbeck responded in the
negative. He continued that the plan sought to do three
things: to close a budget gap, to solve the issues of
spending down savings, and to have a long-term plan for
sustaining government.
1:36:19 PM
CRAIG RICHARDS, ATTORNEY GENERAL, DEPARTMENT OF LAW,
relayed he would be presenting the plan in the bill: the
Alaska Permanent Fund Protections Act. As he reviewed the
elements of the bill package he would be discussing the
reasoning behind certain decisions that were made relative
to other options. He would conclude his presentation with a
brief sectional review of HB 245.
Attorney General Richards began with slide 12: "Overview."
He suggested that the APFPA was fairly simple when viewed
in relation to how the PF was currently structured. The
plan changed three things. First, it took out $3.3 billion
per year from the PF as an endowment fund and placed it
into the general fund (GF). He explained that currently the
only external money drawn from the PF was the dividend. The
governor's plan added a spend rule to the existing rules-
based framework around the PF. The second change reflected
in the bill was that it placed 100 percent of royalties and
100 percent of production taxes directly into the PF fund
each year. Currently under the constitution, 25 percent of
all royalties went directly into the corpus. The plan did
not propose changing that provision since it was
constitutionally mandated. He added that there had been
some statutory rules that had historically deposited
slightly more than 25 percent, about 30 percent, of
royalties into the corpus. The plan he was presenting
placed 100 percent of royalty and production taxes percent
into the PF in order to address volatility and to create
some sustainable spending options. The third piece the bill
changed was how the dividend was paid. The bill changed the
dividend payout rule, the method by which the state
calculated how it paid the dividend. Currently, the
dividend was based on a five-year average of half of the
earnings of the fund. Historically, the formula had worked
fine. However, the governor was proposing an alternative
formulation where the dividend was based on 50 percent of
the year's royalties.
Co-Chair Thompson acknowledged that Representative Lance
Pruitt had joined the committee and recognized
Representative Cathy Tilton in the audience.
Representative Guttenberg referred to number 3 on Slide 12.
He asked if Attorney General Richards had done a comparison
of the dividend payout with the suggested 50 percent
royalties paid from the Earnings Reserve Account (ERA).
Attorney General Richards clarified whether the
representative was asking if the Department of Law (DOL)
had gone back historically to see what the divided would
have been if the state had based the dividend payout on a
50 percent royalty.
Representative Guttenberg responded in the affirmative.
Attorney General Richards had seen such a comparison and
would provide it to his office through the chairman.
1:40:17 PM
Attorney General Richards reviewed slide 13: "Alaska
Permanent Fund Protection Act":
1. Protect the corpus
2. Protect the dividend
3. Grow the fund
4. Stabilize the budget
5. Stabilize the economy
Attorney General Richards indicated that the slide laid out
the goals developed for the administration with the
consideration of adopting an endowment model for the PF.
The goals included protecting the corpus of the fund, the
constitutionally protected principle of the fund that could
not be spent. Another aim was to ensure and protect a
dividend. He pointed out that without change in the status
quo, funding for dividend payouts would run out by about FY
22. One focus of the legislation was on continuing to grow
the fund to avoid a static value over time - the
administration wanted to ensure the fund maintained its
relative value for the next generation. The bill would also
adopt a spending rule, tapping PF earnings in some capacity
to help stabilize the budget shortfall, moving from an oil
based economy to one that was based on both oil and
financial assets for budgeting purposes. Lastly, the
administration hoped that, throughout the use of all of the
changes in the governor's plan including the PF, the plan
would help to stabilize Alaska's economy.
Attorney General Richards quoted Governor Jay Hammond in
slide 15: "The Permanent Fund."
"I wanted to transform oil wells pumping oil for a
finite period into money wells pumping money for
infinity."
Attorney General Richards thought the quote captured what
Governor Hammond was thinking when the PF was established.
He realized that oil was fundamentally a depletable asset.
Given a long enough period of time with conventional
reservoirs, production levels would be lower than when the
development of the basin first began. The following
generation would not have access to the same level of
natural resources that the prior generation enjoyed.
Co-Chair Neuman referred back to item 5 on Slide 13
regarding stabilizing the economy. He commented that in the
previous year the State of Alaska placed approximately $1.4
billion of cash into Alaska's economy through the PFD. He
asked if there had been any analysis about the economic
impact of less cash going into Alaska's economy. Attorney
General Richards deferred to Commissioner Hoffbeck, as he
had worked with Dr. Gunnar Knapp on the issue.
Commissioner Hoffbeck reported that Dr. Knapp had completed
an analysis in a report that was pending and was expected
to be delivered in the current day. He had looked at the
impacts of reducing the size of the dividend compared to
the other options in the plan.
Co-Chair Neuman wondered if Commissioner Hoffbeck had asked
Mr. Knapp to do an analysis on the impact of Alaskans with
different levels of income losing the dividend. It would
impact Alaskans with and income of $20 thousand per year
much differently than Alaskans with an income of $200
thousand per year. Commissioner Hoffbeck confirmed that a
less detailed analysis had been requested. It would outline
how it would affect people with different levels of income
as well as how it would affect different regions of Alaska.
Co-Chair Neuman looked forward to receiving the information
as soon as possible.
1:44:39 PM
Representative Wilson asked to return to page 15. She
agreed that the reserves were established to potentially be
used for spending. However, the current discussion was not
only about using the reserves but also about using PFD
monies. She was uncertain Governor Hammond ever intended to
use the PFD monies for government spending. She wondered
where in any of Governor Hammond's comments he thought the
dividends should be changed or were not a high priority.
She saw the money that went into the corpus as the peoples'
money. The Permanent Fund Dividend (PFD) was the payoff for
Alaskans annually. She did not believe the sentiment was
being reflected in the quote.
Attorney General Richards explained that the quote was from
1976 before the PF had been designed. The Earnings Reserve
Account had not been set up at that time and the dividend
payout formulation that was first adopted (Alaska Inc. and
ultimately rejected by the U.S. Supreme Court) had not yet
been adopted. He thought it had been a formational time in
terms of people's thinking about the PF. His personal view
aligned with something David Rose, one of the first
executive directors, had told him a number of years prior:
one of the successes of the PF was that not every piece was
defined as to its purpose. Different people could interpret
its utility in different ways. Mr. Rose thought how the
dividend played relative to what amount it should be, how
it should be calculated, and ultimately determining a fair
share between supporting government versus direct payouts
to the people were things different people could rationally
differ on.
Representative Wilson could agree somewhat with Attorney
General Richards's rationale if the government had not
already received its share. However, because Alaska did not
own the subsurface rights on most of its properties and the
dividend was there to help offset that circumstance, she
thought the whole of the state would be able to receive a
royalty payment. She wanted to make sure that when quoting
Governor Hammond no one should try to make it appear that
the governor had ever thought the dividend portion would go
away.
Attorney General Richards understood her point. He did not
mean to suggest that Governor Hammond or any other governor
had rigidly defined what share belonged to the people and
what share was properly usable for governmental services.
Representative Guttenberg returned to slide 13. He
commented that he thought all of the money (the Permanent
Fund monies) belonged to the people. He suggested that when
stabilizing the budget and dealing with the operations of
the state government it was simply about the delivery of
services to the people of the state. He asked if there was
an analysis about cutting the PFD, which he was deeply
concerned about having represented a sizable portion of
Rural Alaska. He wondered about the impacts of budget cuts
and about how the deletion of services would affect the
private economy.
1:49:00 PM
Commissioner Hoffbeck stated that the information
Representative Guttenberg was inquiring about would be
included in the forthcoming analysis. The analysis included
looking at the impact of reducing the size of the dividend,
using earnings, making cuts to services, and imposing taxes
including an income tax. They were compared against each
other as far as the relative impacts on the economy.
Representative Guttenberg asked if the "do nothing" option
would be included in the analysis. Commissioner Hoffbeck
suggested that the impacts of the changes were compared to
the status quo.
Representative Gara referred back to slide 15. He wanted
the administration to refrain from speaking for Governor
Hammond. He had become very good friends with Governor
Hammond in his later years. He suggested that the governor
had said many things based on the context of the time. He
relayed that one of the things the former governor had said
to him frequently was that if the state was going to have a
fiscal plan and there was a problem the state should
address it by getting a fair share for the state's oil
first, then impose an income tax, and if needed tapping
into the PF. He did not feel that it was useful for people
to co-op Governor Hammond. The governor had said things at
various times. He discouraged others from invoking Governor
Hammond as the supporter of anyone's plan.
Co-Chair Thompson thanked Representative Gara for his
statement.
Attorney General Richards noted Representative Gara's
feedback and would be removing the slide from the
presentation.
Attorney General Richards jumped to slide 17: "Defining
"Sustainable"" indicating he would come back to slide 16
later in his presentation. He explained that the
administration posed the question that if the state was
going to create a spending rule that put some amount of the
PF earnings into the GF the state would have to clearly
define "sustainable." The state was aware it wanted to have
a PF that was sustainable; loosely meaning it would have a
like or greater value for the next generation of Alaskans
in perpetuity. In financial modeling it was not enough to
have a vague idea of the meaning of a sustainable PF.
Ultimately, the administration broke it down into three
parts. The first key piece was leaving the corpus of the PF
untouched, consistent with the constitution.
Attorney General Richards explained the second part. If the
state was going to adopt an endowment model where the
government relied on funds from the PF for its ongoing
operations, there had to be a durable earnings reserve
account (a consequence of the first part that the corpus
could not be spent). In other words, if the state was going
to rely on PF monies from year-to-year, then there needed
to be assurances in place that the money would be available
each year. In anticipation of a couple of bad market years
or other unexpected events, the earnings reserve account
initially needed to be large enough to ensure its
durability to avoid falling below zero. Otherwise, the
state would simply be exchanging one budget hole for a
different kind of budget hole.
Attorney General Richards relayed that the third part was
the definition [of sustainable] the administration adopted.
In order to be sustainable the PF value needed to maintain
its real value. He explained that a nominal value did not
take inflation into consideration. Whereas, a real value
did. The fund's value would grow at an amount that at least
equaled inflation. The state's sustainability rule was
designed with a target of maintaining the real value of the
fund or growing it over time.
Attorney General Richards furthered that the administration
had an inflation rule embedded in its economic modeling
that accounted for inflation. He explained that the state
went farther to provide a mechanism that not only protected
the total value of the fund against inflation, but actually
adopted a mechanism of inflation-proofing similar to the
current system where inflation-like funds were put into the
corpus so the corpus, itself, grew. He would be talking
about how the formulation used in the plan of growing the
corpus for inflation adjustments was different than what
was currently in place.
1:54:42 PM
Co-Chair Neuman mentioned the earnings reserve durability
and expressed his concern about having members of the
cabinet on the board of the Permanent Fund Corporation
(PFC). He presented a hypothetical situation in which the
corporation ended up in a deficit situation. He wondered if
the PFC board would be inclined to sell assets to ensure
that there was available funding for the state to pay its
bills. He suggested that in the governor's plan the
Permanent Fund's sole purpose was to fund government. The
Permanent Fund Dividend check would be solely dependent on
production taxes and royalty revenues. There was a big
switch in how things would be done in the new plan. He
asked Attorney General Richards if he had contemplated a
way in which the administration and the legislature could
work together in resolving the issue of how the PF was
managed and by whom.
Attorney General Richards stated that after having visited
in Co-Chair Neuman's office he had had time to think about
their conversation. He and Commissioner Hoffbeck were both
members of the PF board. As a member of the board he had a
legal fiduciary obligation to manage the fund as a trustee
under fairly well-defined legal standards. The obligation
superseded the obligation as a member of the governor's
cabinet. It was the same obligation, in terms of
management, that a person would have as a cabinet member or
a non-cabinet member appointed by the governor. In his mind
the trade-off of having commissioners sitting on the board
aware of what the administration was doing was more
beneficial than having increased political independence
with non-cabinet members sitting on the board.
Co-Chair Neuman reported that his point was to ensure that
other members of the finance committee and the public were
aware of the conversations he had had with Attorney General
Richards. He reiterated his concerns with having cabinet
members sitting on the PFC board.
1:58:04 PM
Representative Munoz asked if the PFC board or its staff
considered mandatory changes in the investment mix with the
requirements of an annual cash draw. She was unclear
whether there would be a change in management.
Commissioner Hoffbeck stated that currently the trustees
and the managers of the fund had not looked at changing the
mix of investments. As part of the plan, the corporation
and board of trustees would have to remain autonomous from
government intervention. He asserted that it was the only
way a rules-based system worked. The board's focus would
have to be on generating returns rather than specific money
generating components. The size of the cash portion would
be larger than in the past because previously the dividend
was the only item being paid from the draw. With the
governor's plan in place it would pay something essentially
2 to 2.5 times the amount of the prior year's dividend. The
corporation would have to manage for more cash annually but
there would be a known draw in the future and the PF could
be managed accordingly. Overall he did not believe the
underlying investment portfolio would change to any extent.
Co-Chair Thompson argued that it would be difficult to
remain autonomous with a governor trying to draw additional
money out with a number of his cabinet members on the
board.
2:00:18 PM
Attorney General Richards commented that the amount drawn
from the fund was a legislative prerogative. The two
potential outflows were monies to the GF and the dividend
amounts. Both amounts were determined by the legislature.
Attorney General Richards continued to slide 18: "APFPA
Cash Flows." He pointed out that the slide showed a visual
depiction of the governor's plan. It showed how cash flowed
in and out of the system. He drew attention to the corpus
of the PF on the left and the earnings reserve account
(ERA) in the middle of the slide. In the governor's plan 25
percent of mineral royalties automatically went into the
corpus of the fund, a constitutional requirement. The
remaining 75 percent of royalties and 100 percent of
production taxes would be placed into the ERA. Two
different cash flows would come out of the ERA. A fixed
amount of $3.3 billion would be placed into the GF. The
payment of dividends would also come out of the ERA.
Currently, what came out of the corpus was the state's
statutory net income (the earnings of the principle of the
fund) and an allowance for inflation-proofing (taken from
the ERA and returned to the corpus).
Attorney General Richards explained how the governor's plan
changed how the ERA functioned. In the plan the ERA would
hold statutory net income, royalty monies, and production
tax funds. These monies would remain in the ERA until the
account reached four times the size of the payout (4 x $3.3
billion). It was a mechanism that would allow the state to
have 4 years of anticipated draws in the ERA providing for
a high level of durability even if the state had poor stock
market years or the price of oil went down further. The
state would have a very robust smaller tank of savings to
be able to make the dividend payments in a $3.3 billion
draw each year. Once the target was reached, anything over
the target would be placed back into the corpus of the fund
as a form of inflation-proofing. He concluded that the
governor's plan changed the plumbing of the system.
Attorney General Richards addressed why the governor was
proposing the change. The proposal put the state's three
largest sources of income (income on financial assets from
the PF, production taxes, and royalties) into a common pot.
The plan included monitoring the three cash flow sources to
determine the amount to draw as an annuity year-to-year at
a level such that it could be done in perpetuity. Rather
than trying to live on the summation of three different
volatilities from year-to-year, the administration was
suggesting drawing down a fixed amount. He compared the
idea to a person might have two options to draw from
financial assets in retirement. A person could draw an
amount that equaled a percentage of financial assets every
year. It would mean that a person would be living on a
variable income based upon asset size. A person could also
draw a fixed amount based on a person's total amount of
assets, taking only an amount that would perpetuate a
stable fixed income. He viewed the governor's plan similar
to the later providing stability to the budget year-to-
year.
2:05:43 PM
Attorney General Richards moved to slide 19: "How to handle
the draw." He reported that the administration had not
known what it would view as the more optimal approach until
modeling was applied trying many different things. Prior to
addressing volatility, the administration posed a question
about the definition of sustainability. The answer it came
up with was that under a Percentage of Market Value (POMW)
about $2.4 could be taken out of the PF in the current
year. Out of the $2.4 billion historically about $1.4 had
been allocated for dividends. Currently about $1 billion
could be placed into the GF. The administration opted to
do it a little differently by placing production and
royalty taxes into the Permanent Fund to stabilize the
amount and help close the gap. If the state were to adopt
an endowment model for the PF, the issue of how to handle
the draw had to be addressed: should it be done as a
percentage value of the fund or as a fixed amount. He
encouraged the legislature to review the consequences of
both options.
Attorney General Richards stated that it was not obvious
which option was better. He relayed that there were pros
and cons to both a percentage system and a fixed system.
The advantage to the POMV system, the percentage system,
was that there would be less certainty to the budget but
more certainty to the fund. In other words, if the fund
went down the amount drawn to the budget would go down as
well. Conversely, if the value of the PF went up, the
amount drawn into the budget would go up. It created a
self-adjusting mechanism for the PF. The mechanism would
help to protect the fund against the risk of being run down
as quickly if there was a string of bad luck. However,
variability would be housed in the state's year-to-year
budget rather than in the fund itself.
Attorney General Richards moved on to discuss a fixed
system, reflected in the governor's plan and lacking an
automatic adjusting mechanism. If there was a period of bad
years, then $3.3 billion might be too big of an annuity to
draw. Under such circumstances, the state would need a
method to adjust the draw down. He reported that the
periodic review was included as part of the governor's plan
as a means to adjust the draw down. The periodic review,
conducted every 4 years, was a way to look at whether the
amount the state would be drawing was sustainable.
Attorney General Richards maintained that the main question
was whether the state wanted stock market volatility
residing in the payment to the budget or whether the state
wanted the payment to the budget to be fixed and the stock
market volatility to reside more in the PF. The governor's
plan chose to have more stability in the GF and more
volatility in the PF. He concluded that both plans were
reasonable.
2:09:31 PM
Co-Chair Neuman relayed that the one thing the state had
was historical numbers on the investments for the Permanent
Fund. He asked if Attorney General Richards had taken both
the fixed system and the percentage system methods and
applied them to historical data for comparison. If so, he
requested to see those numbers. Attorney General Richards
relayed that the administration had done the modeling a
number of ways and would provide the information to the
committee.
Co-Chair Neuman asked for the information.
Co-Chair Thompson reiterated that the information be
provided to the committee.
Attorney General Richards continued to address slide 19. He
relayed that there were two decisions that would have to be
made by the legislature if it adopted an endowment model.
The first was whether to choose a fixed draw system or a
percentage value system. He stated that petroleum revenues
were not static due to production levels changing. He
recommended that, in looking at the POMV system option, the
legislature should take into account that the percentage
that could be withdrawn currently was less than the
percentage that could be drawn in the future if petroleum
production declined. Conversely, if petroleum production
increased, then in the future the sustainable percentage
draw would be slightly higher. He recommended using a
periodic review as a mechanism for measuring sustainability
with the POMV system. He also noted that the PF, itself,
held debt. It was not just cash or equity, the PF had a
large real estate portfolio using debt: the corporation
borrowed money to invest in real estate. The consequence of
that was when a percentage draw was defined the state would
have to make sure to draw on a percentage of the net value
of assets and not on the value of assets with debt.
Co-Chair Neuman asked Attorney General Richards to give a
more coherent explanation. Attorney General Richards
explained that about 6 months ago the PF had a debt of
roughly $7 billion in its portfolio. The debt resided in
the PFC's real estate, hedge funds, and some of its private
equity portfolio. The state would not want to borrow money,
then calculate the total draw based on the value with the
debt included. The state would end up borrowing money then
immediately paying it out. The state would need to make
sure that it was paying either dividends or the payment to
the government using a method that did not payout on the
borrowed monies.
Co-Chair Neuman did not believe the PFD [calculation]
accounted for unrealized assets or debt at present. He
wondered why the corporation would want to start such a
process. Attorney General Richards explained that if the
state did not change the dividend formula, it would not be
an issue. However, if the legislature adopted a POMV
approach to the fund draw down then the definition would
need to be clear. The debt would need to be taken out of
the total calculation of a POMV draw of 4.5 percent, for
example.
Co-Chair Neuman did not believe it could be done legally
anyway.
2:14:11 PM
Representative Gara had not seen the math on paper but
understood that the governor's plan promised a $1000
dividend for the first 2 years. There was significant
concern that the 50 percent of Alaskans whom earn the least
amount of money received about 20 percent of their income
from the dividend. He reported hearing about $400 dividends
following the first 2 years of $1000 dividends, based on
some oil price scenarios. He asked about potential
scenarios after the first 2 years that would decrease the
dividend to $400.
Co-Chair Thompson asked him to also comment on production
scenarios accounting for increased production.
Commissioner Hoffbeck made a correction that the governor
only guaranteed $1000 for the first year rather than for
the first 2 years. He added that if the revenue forecast in
the Revenue Sources Book was used for price and production
the dividend would decrease to between $700 and $800 in
year 2. If the calculation was based on current oil prices
at about $30 per barrel then the dividend would decline to
between $400 and $500 in the second year. Much would depend
on oil price recovery over the following year. The dividend
would track with the state's overall economic health under
the governor's plan.
Attorney General Richards reported that slide 20: "How to
handle the draw: A simple endowment draw adds revenue, but
does not address volatility": reflected a hypothetical
scenario. He explained that the blue bars demonstrated
historically what the unrestricted petroleum revenues were
to the state. Like other oil based economies, it was very
difficult for Alaska to budget year-to-year with volatile
fluctuations in the unrestricted petroleum revenues (70 to
90 percent of the total state budget). The slide
demonstrated a problem with the classical POMV system as
Alaska had currently contemplated. The yellow bars
reflected what the POMV would have added into the GF after
the dividend payment had the state adopted a 4.5 percent
POMV in 2002. It was an exercise going back in time. He
furthered that the slide demonstrated that in years of low
oil prices the classical POMV endowment model was useful
because the state would be getting revenues from financial
assets when needed because of oil prices being low in the
classical system. In poor years it helped close the gap.
However, without a rule-based system that accounted for
high oil price years the POMV model compounded the problem.
In the years when the state was getting more petroleum
revenues than needed the state had the tendency for pro-
cyclical spending resulting in large capital budgets and
growing operating budgets that would have to be clawed back
in later years. He suggested that the state might not want
a POMV that paid from its financial assets when oil
revenues were high because more aggressive spending would
likely take place. He advised that if the legislature opted
for the POMV system, members should be cognizant of making
sure a rule was in place preventing money from being pumped
in from the state's financial assets into the budget which
would otherwise compound the pro-cyclical spending pattern.
2:19:09 PM
Representative Wilson asked what the dividend would have
been in 2012 under the governor's plans. Attorney General
Richards did not know the exact number but estimated it to
be roughly $1300. He elaborated that royalties in 2012 were
about $2 billion.
Representative Wilson asked what the dividend would have
been in 2008. There would be a difference in the POMV
addition. She wondered if it would be greater than $1300
due to the unrestricted petroleum revenue. Attorney General
Richards responded that the dividend would have been large
in 2008.
Representative Wilson commented that in 2008 and 2009 the
dividend amount was not very exciting due to the stock
market. She wondered if the plan would change how the
dividend was handled. Although the state did not receive
extra in the big years such as 2008 and 2012, she wondered
what the justification would be to change when looking at
low numbers in the following couple of years.
Attorney General Richards remarked that the governor's plan
proposed changing the way the dividend was paid so that
individual Alaskans were rewarded when the economy was
doing well as opposed to a dividend system that rewarded
Alaskans for financial market success. Either system was
rational but the governor felt that Alaska was better
aligned if its people were successful when the economy was
doing well.
Representative Wilson commented that she would otherwise
agree with the governor's position if the state was looking
at an increase going forward. However, the state was facing
a decrease. She felt that the people of Alaska had already
taken a hit because of the stock market. She felt that the
administration was asking Alaskans to take a second hit
because of the change in oil revenue.
Commissioner Hoffbeck replied that the state had to start
somewhere. He asserted that the state was in a situation
driven by economics where the state had to make some
decisions that would otherwise not be required under
different circumstances.
Attorney General Richards added that there was a fairly
conservative 20 year production forecast from the
Department of Revenue (DOR). It assumed steady decline
because it anticipated that the state would not have much
success in the form of new fields, a gas line, or in the
Arctic National Wildlife Refuge (ANWR). He thought it made
sense from a budgetary perspective to have a conservative-
based assumption. He thought that a really pessimistic
assumption about the future would carry over to the royalty
dividend. Conversely, if there was a positive outlook at
higher oil prices or more success in Alaska's petroleum or
mining sectors in the future, then the royalty dividend
would look higher.
2:22:59 PM
Co-Chair Neuman asked how the dividend would be calculated
in the POMV example.
Attorney General Richards responded that it was a
historical actual payout. The numbers were historical
numbers and the actual payout was already known.
Co-Chair Neuman confirmed that the payout was calculated
under the current dividend calculation method. Attorney
General Richards responded in the affirmative.
Vice-Chair Saddler asked why nominal dollars would be used
over a 40-year period rather than using real dollars to
account for inflation. Attorney General Richards suggested
that originally the chart used real dollars but he later
decided to stick with one convention in the presentation
choosing to use nominal figures to avoid confusion. The
real dollar chart communicated similar information.
Vice-Chair Saddler noted that the Attorney General had
stated earlier that he wanted to make the PFD more
connected to the people based on the health of the economy
(oil royalties). He asserted that Attorney General Richards
wanted to make the PFD work well when oil wells were
pumping oil rather than when money wells were pumping more
money, which they were currently.
Representative Gara mentioned talking about the dividend
amount. Two of the largest parts of the governor's plan
were the dividend change and the income tax. He indicated
that everyone was looking for a plan that would be
comprehensive and fair to everyone. He wondered how he
would explain the current plan to his constituents in the
low income parts of his district who would be affected the
most.
Commissioner Hoffbeck responded that there was some balance
between the income tax and the dividend in that the income
tax impacted people earning higher wages more than those
earning lower wages. Conversely, reducing the size of the
dividend impacted lower wage earners more than it did for
those earning higher wages. However, he argued that the
income tax impacted the higher wage earners at a higher
percentage. One of the things the administration tried to
recognize was that the dividend had been volatile over the
years. The dividend would go up and down under any
scenario. The bill changed the dynamics. The bill provided
for a smaller dividend than did the current system, but
doing nothing created the possibility of losing the
dividend altogether within 4 years. He added that part of
the intent of the bill was to be able to sustain the
dividend long-term.
2:27:38 PM
Representative Gara thought the state should have a
balanced plan but he took issue with the definition of
balanced.
Vice-Chair Saddler asked about the threshold for a person
to have a net payment of federal taxes notwithstanding the
earned income tax. He was looking for a perspective on how
much income a person who was heavily dependent on a PFD
would actually pay in taxes. Commissioner Hoffbeck put into
perspective that someone with a family of 4 that made $50
thousand per year would pay about $47 in state tax, close
to the tax threshold.
2:28:42 PM
Representative Gara spoke to the reduction of the dividend
to $500 or $800 in the out years. The revenue the state
would be generating by reducing the dividend was about 4
times as much as the $200 million towards a $4 billion
deficit that the state would raise from the income tax. He
asked if the income tax would generate about $200 million.
Commissioner Hoffbeck replied in the affirmative. In
looking at the federal tax liability, since the state was
tied to it, between 40 and 50 percent of people did not pay
federal tax. The same dynamic would apply to a state income
tax. About half of the reduction in the dividend was out of
the higher wage earner. In looking at the impact of the
lower wage earner about $350 million would be taken from
the dividend system. A state income tax would generate
about $200 million.
Co-Chair Thompson reminded members that the committee would
be addressing a separate bill on income tax. Committee
members would be supplied with more explanations on the
numbers in the future.
Attorney General Richards mentioned that in the following 2
slides he would be reviewing the assumptions of the
governor's plan used in the model. He addressed slide 21:
"Calculating the Draw: The Financial Model." He explained
that the governor's plan relied on probabilistic modeling
for many of its inputs. It meant that rather than picking a
discrete oil price or return assumption, the economic
modelers built a range of potential prices and assigned
probabilities of being at certain prices over time. It
created a more sophisticated way of doing the modeling
rather than choosing static variables. He relayed that
Mackenzie [Wood Mackenzie] would provide a much more
detailed presentation to the committee at a later time
outlining how they vetted all of the assumptions in great
detail, why certain assumptions were reasonable, and why
other assumptions were changed to reflect better thinking.
Attorney General Richards continued. He explained that the
PF modeling assumed that the starting assets equaled $55
billion. The $55 billion included the PF projected value as
of the end of the fiscal year (FY 16). A point in time
needed to be chosen in order to build the models. He
reported that the PF had lost a value of about $3 billion
in the previous 3 to 4 months. He thought the number was
higher than in the current day. If there was an assumption
of $2 billion less than the starting assets in the
governor's plan, then there was about $100 million less
than the state could have in its sustainable draw. It was
possible in the decision that the state would use $53
billion rather than using $55 billion, for instance, which
would result in a draw of $3.2 billion versus a $3.3
billion draw. He believed that getting the exact beginning
principle accurate was not as important as it was to make
reasonable assumptions about long term returns for the
state. It was important to make good assumptions about what
would likely occur over time. He noted that of the $55
billion, $3 billion was an assumed transfer from the CBR
into the ERA. The $3 billion was to provide a level of
confidence to ensure that the ERA was going to be large
enough to compensate for a couple of years of bad stock
market returns. It would provide a cushion enabling the
state to make a $3.3 billion draw each year.
2:33:28 PM
Co-Chair Neuman asked about the sustainable budget
baseline. He wondered if it was the governor's current $5.4
billion budget.
Attorney General Richards replied that the current
legislation did not assume any particular budget. Instead
it determined what could be pulled out of the PF every year
that met the definition of sustainability. The number,
under the way the governor's plan was calculated for the
PF, was $3.3 billion regardless of the budget every year.
For instance, if the budget was $6 billion only $3.3
billion could be withdrawn. If the budget was $4 billion
only $3.3 billion could be taken out. The sustainable draw
amount of $3.3 billion was independent of the budget.
Co-Chair Neuman assumed a starting budget of $5.4 billion
like the governor's proposed budget. He asked if it would
prove to be more beneficial for the budget if the
legislature could reduce it to $4.5 billion or $4.7
billion.
Attorney General Richards deferred to Commissioner
Hoffbeck.
Commissioner Hoffbeck answered that if the budget was
reduced by only $700 million of about $2.1 billion to $2.3
billion needed to balance the budget, it would reduce the
state's future draw by about $100 million to $120 million.
The state would have to draw down on saving to make up the
remaining funding. The amount the budget fell short reduced
the amount that the state would have going into the future.
He had received a matrix immediately before the meeting and
had not had a chance to vet it. It would be part of the
packet the DOR would be providing to members.
Co-Chair Neuman asked if the commissioner had just stated
that if legislators did not take any action in the current
year the required draw down would be reduced by $100
million.
Commissioner Hoffbeck replied that if the state did not do
anything in the current year except to pass the budget it
would reduce the sustainable portion of the draw by about
$150 million annually. The state's draw would be $3.15
billion rather than the current year's figure of $3.3
billion. He added that the state would never recover the
difference.
Attorney General Richards added that it was accurate based
on his understanding of the modeling from the DOR. However,
there were also consequences to delaying in addition to the
reduced sustained draw. He would be discussing the
consequences of delay at Representative Edgmon's request.
2:37:03 PM
Representative Munoz asked if he had looked at the
financial model without the $3 billion CBR draw. She asked
for the specific number of a sustainable draw without the
investment.
Attorney General Richards stated that he had looked at the
model and claimed that the draw would be reduced by
approximately $150 million. The negative impact would be
that the amount in the ERA might be less robust rather than
impacting the amount of the sustainable draw. The risk of
running the ERA down to zero would intensify if the stock
market did poorly in the following 2 years. The $3 billion
was not added to increase the total amount of sustainable
draw. It was inserted to ensure a robust ERA balance of
approximately $10 billion.
Representative Munoz asked if the plan required an annual
draw from the CBR.
Attorney General Richards responded that it was a one-time
draw from the CBR to make the earnings reserve sustainable.
He reported that there were aspects of the plan not related
to the APFPA that had some different assumptions.
Commissioner Hoffbeck replied that there was an ongoing
draw from the PF because the administration anticipated
needing about $100 million to $150 million per year in
investment returns out of the CBR. If money did not get
drawn from the CBR and placed into the ERA the state could
still make the draw from the CBR annually. The draw would
be smaller from the ERA and make the difference with a draw
from the CBR. Once the plan was in place the CBR would be
invested similarly to the PF. The instability of having the
money in the CBR was having to access it with a required
three-quarter vote of the legislature.
Attorney General Richards added that the true advantage was
having the $3 billion in the PF rather than the money
residing in the CBR. The Permanent Fund would become self-
sustaining generating the dividends and about $3.3 billion
on its own without having to pull from another piece. He
mentioned the importance of having a rules-based framework.
The success of this part of the plan, dependent on a
political element such as a successful CBR vote, made the
plan a little less robust from a rules-based perspective.
2:40:52 PM
Representative Edgmon wanted to make clear that the total
return in the statutory net income was part and parcel of
one portfolio, the corpus of the PF and the earnings
reserve being managed as one entity. He saw nods at the
table. He asked whether the modeling demonstrated the
corpus continuing to grow proportionately, looking 4 years
down the road and after drawing down each year, so to avoid
having a larger amount of investments in more liquid assets
such as the Earnings Reserve. He wanted a quick comment
about what the modeling showed. He was thinking about the
portfolio and the make-up of the asset allocation. He
suggested that a more aggressive investment might be
necessary to meet the targets of the Earnings Reserve if
the corpus was not keeping pace.
Attorney General Richards responded that the earnings
reserve and the corpus of the fund were managed the same
and, he did not see any change. The way the PF accounted
for the two was an accounting exercise on paper. It was not
as if they were managed as separate funds managed in
different ways. In terms of how money was accounted for in
the corpus versus the earnings reserve, it was not very
impactful from a management standpoint. It came down to
whether the money was available to draw when needed. He
addressed Representative Edgmon's second question. The
growth of the corpus, under the governor's plan, went back
into the corpus after the making payments to the
government's GF, paying out the PFD's, and reaching the 4:1
target level. It was not the same as an inflation-proofing
type of growth that the corpus had currently, it would be
less in the early years until the target of $13 billion was
reached. Once the target was reached the inflationary
growth would go into the corpus.
Representative Edgmon thought there would plenty of room
for comments because the permutations were endless at the
current stage of discussion.
Representative Gara asked if $13 billion (4 years x the
draw) was the amount recommended to keep in the ERA. He
commented that every time he looked at the constitution and
at Legislative Research's analysis of the issue they stated
that GF available for appropriations at the end of the year
should be swept into the CBR. Currently, there was about $6
billion in the CBR. Under the proposed legislation the
state would have $13 billion at the end of every year. If
the Legislative Finance Division (LFD) was correct the $13
billion would get swept into the CBR. If Attorney General
Richards was correct the money would not get swept into the
CBR. He thought that LFD's interpretation was closer to the
constitution. The legislature would be left with needing a
three-quarter vote every year to make the governor's plan
work. He thought the requirement made it less stable with
changing legislators at different times and wondered if
Attorney General Richards agreed.
Attorney General Richards responded that if one looked at
the history of the CBR sweep and the reverse sweep in
particular, the legislature had always exercised the
reverse sweep. He suggested that the question would not
come up about the provision applied to the ERA, unless
there was a change in how the legislature conducted its
business. If the state did not do a reverse sweep it would
not only impact the ERA, it would also affect a wide number
of accounts. He listed a number of examples including
pension assets and some of the mental health trust funds.
He surmised that it would be a big change in the system to
arrive at the question. The administration viewed the
option of the legislature not doing a reverse sweep as a
low-probability event. If the legislature did not, the
state would be in a situation in which someone could
challenge whether the ERA was subject to a sweep. The state
already had a Supreme Court decision that stated that the
earnings reserve was not subject to a sweep. The question
about the ERA changing the nature of the Supreme Court's
decision could come up if the state did something
differently than it did traditionally; either monies were
coming out of the ERA into the GF, or monies from
production taxes and royalties were going into the ERA. The
Department of Law did not believe the Supreme Court would
change its mind. If two low-probably events occurred, the
state did not do a reverse sweep, and the Supreme Court
changed its mind then potentially the earnings reserve
could go to the CBR and the Supreme Court held. The
administration went forward with the plan as designed
because the probability of the two events occurring was
low. Even if the very low probability event occurred the
state would have a Supreme Court ruling that stated how the
system worked and the state would redesign the system to
accommodate it in a way that made sense.
2:47:19 PM
Co-Chair Thompson relayed that the committee would be
addressing the question at a later meeting.
Representative Gara understood that the subject would be
addressed later and commented that the court would not
reverse its opinion. The court's previous opinion on the
earnings reserve was based on it being used solely for the
PFD and inflation-proofing. Under the plan currently being
proposed the earnings reserve would be used to fund general
government. He added that the Supreme Court would not
change its opinion, but rather change the purpose of the
ERA which was the Legislative Finance Division's analysis.
Attorney General Richards commented that he looked forward
to a future opportunity to debate the issue with
Representative Gara.
Vice-Chair Saddler suggested that the SBR and CBR had been
the state's emergency "go-to" money for deficit situations.
The legislation would get rid of the CBR by placing it into
the ERA. He wondered about the emergency capacity for
spending if the state experienced an earthquake, a flood,
or oil prices went down to $8 or $4 per barrel. He wondered
if the money would be in the ERA.
Attorney General Richards responded that the governor's
plan only placed about half of the CBR into the ERA. The
most recent balance in the CBR was about $7 billion. The
plan would place $3 billion in the ERA leaving $4 billion
in the CBR which would either be appropriated in the
current year or remain in a stabilization account: a short
term account used to meet emergency needs or to close
current year budget gaps. The plan did not eliminate all of
the funds by placing the funds into the PF, only $3 billion
of the $7 billion.
Vice-Chair Saddler clarified that Attorney General Richards
was talking about $3 billion of the $7 billion in the CBR.
He noted he was only seeing $3 billion in the CBR, not $7
billion. He saw $7 billion in the ERA.
Attorney General Richards relayed that one represented an
amount and one represented a cash flow. He reported that
there would still be about $2 billion in the CBR to fill a
need.
Attorney General Richards advanced to slide 22:
"Calculating the Draw: The Petroleum Model." He informed
the committee that the administration used a probabilistic
method in its petroleum modeling. There had been a question
about why the petroleum revenue projections in the APFPA
modeling were slightly different than in some of the
budgetary projections. He explained that rather than basing
all of the projections on one price, a range of oil prices
was used and each price was assigned a probability of
occurrence. The consequence of applying a range was that
the revenue collected differed from when an average was
applied. The state had a progressive tax system. Less
revenues would be collected at $50 per barrel of oil than
if $50 per barrel was the mean with the chance of the price
of oil reaching $100 per barrel. At progressive rates it
was a much larger number than the mean $50. In other words,
by capturing a range of oil prices (rather than one price)
future projections were more accurately captured.
Attorney General Richards continued that for production
forecasting a range was not used, but rather the model took
the DOR's production forecast out to 2040 adopting it as a
static. He believed it created a conservative bias to the
model. The Department of Revenue projected development from
known fields and deposits currently in production, and a
small amount of non-currently producing oil in the form of
future development in field. It did not assume any
development from some of the future potential additional
new fields: ANWAR, offshore, and the Outer Continental
Shelf (OCS). It was a conservative view of Alaska's future.
Co-Chair Thompson acknowledged Speaker Mike Chenault in the
audience.
Attorney General Richards summarized the calculation from
the governor's bill and explained how the $3.3 billion was
determined. It started with the balance of the PF as of the
projected end of the period plus the $3 billion assumed in
the model to be transferred to the ERA. It then calculated
how much the state projected in PF investment earnings over
time, how much would be deposited into the PF from
production taxes in the future, and how much would be
deposited into the PF from royalties in the future. It also
accounted for the fact that the PF had expenses, the
dividend payout, and a draw from the PF that went into the
GF under and endowment model. Using the 50 percent royalty
dividend formulation the state would be able to take out
$3.3 billion per year from the PF to the GF. The 2 draws,
(the dividend and the fixed draw) allowed the PF to grow at
the rate of inflation over time.
2:53:42 PM
Representative Munoz asked about other projected GF
revenues outside of the $3.3 billion sustainable draw.
Attorney General Richards responded that there were two
parts to his answer. First, there were revenues already on
the books such as state income taxes and petroleum property
taxes. Second, the governor's total plan placed other new
revenue measures on the table which would not go into the
PF.
Commissioner Hoffbeck confirmed that the corporate income
taxes and the petroleum property taxes were the largest
revenues. There were other revenues that would equal about
$800 million to $850 million in fees and taxes that were
currently on the books. The Department of Revenue projected
an additional $100 million to $150 million in investment
earnings outside of the PF. He concluded that there was
about $1 billion in other revenues that flowed into the GF.
Representative Munoz noted that Commissioner Hoffbeck's
figures brought the total up to about $4 billion. She
wondered how the plan balanced the budget. Commissioner
Hoffbeck mentioned new revenues of about $450 million in
new taxes proposed by the governor and additional cuts. The
governor's plan had about $500 million in reductions.
Co-Chair Thompson referred back to the barrel chart on
slide 18. He noted that the PFD would be based on
royalties. Statements had been made that 50 percent of the
royalties would go towards the PFD payments. In the
scenario on the barrel chart it appeared that 25 percent of
royalties were placed into the corpus and 75 percent into
the ERA. He wondered if 50 percent of the total royalties
would go towards dividends or 50 percent of the 75 percent
that were going into the ERA.
Attorney General Richards responded that it was 50 percent
of total royalties. He added that the 50 percent did not
have to run through the PF. It made sense to do so from an
asset management perspective as well as keeping the
dividend tied to the PF. The administration thought it was
part of Alaska's psyche which made sense to maintain.
2:56:39 PM
Attorney General Richards scrolled to slide 24: "Earnings
Reserve Durability." He indicated that the slide addressed
the sustainability of the earnings reserve. He emphasized
that whatever endowment model was adopted (POMV, the
governor's plan, or another plan) needed to be accompanied
by a high level of confidence that enough money would be
available in the earnings reserve to pay the dividend and
the payout to the GF each year because the constitution
stated that the corpus of the fund could not be touched. If
the state were to run its savings down to zero the state
would be faced with a fiscal hole that could be plugged by
sending less to the GF then planned or by not paying the
dividend as planned. In the administration's plan it
created a high level of certainty by maintaining a target
balance in the ERA of four times the annual payout. Such a
target provided the state 4 years of cash-on-hand to pay
the total draw down each year. He asserted that it was a
fairly robust target figure. He had heard that the Alaska
Mental Health Trust used a similar system, the ratio of
which was smaller. They had been successful in having less
than four times in their payout account.
Vice-Chair Saddler asked if the same conservative, short-
term, cash-based investment standards would be applied to
the funds available to pay dividends. He wondered if it
would decrease the overall take on the corpus and the
earnings reserve.
Attorney General Richards relayed that the earnings reserve
was typically managed the same as the corpus of the PF.
However, if money needed to be withdrawn every year in
addition to the dividends the funds would need to be
managed for more liquidity. Some amount of money would
possibly be managed shorter term, but most likely only a
small percentage. He had discussed the issue with the
Permanent Fund Corporation.
Vice-Chair Saddler commented that he would have accepted
accounting for more volatility at an amount of four times
the expected draw.
2:59:37 PM
Co-Chair Thompson wondered why any excess funds above the
targeted reserve amount would be placed in the corpus
rather than in the SBR or the CBR for emergency purposes.
Attorney General Richards stated that Representative
Thompson's suggestion was feasible and was a policy
decision. However, it would impact the model by no longer
reaching the sustainability goals. If the money was removed
from the PF above the target reserve amount (used for
inflation-proofing the corpus) the corpus would not be
growing the size of the PF equal to inflation. He furthered
that the definition of sustainability would have to change
to exclude inflation-proofing or draw less to account for
the growth in the system.
Attorney General Richards advanced to slide 25: "Earnings
Reserve Durability." He noted that regarding durability the
4:1 target amount was conservative and provided a high
level of confidence and coincided with the state's periodic
review. In the following year and in every 4 years after
there would be an analysis of the sustainability of the
plan, whether the draw amount needed adjusting, and whether
the ERA was sufficiently durable. Having the 4:1 target
ratio in place meant that the state would have about enough
money to provide for the period of time between the 4 year
review cycles.
Representative Guttenberg was unsure whether the 4:1 ratio
was the proper proportion. He assumed that the investment
board conducted the modeling and the reviews. He asked
whether the sufficient time to react had to do with the
investing or the legislature's ability to provide
solutions.
Attorney General Richards reported that the legislation
called for the DOR to conduct periodic reviews with input
from the PF Board of Trustees. The Permanent Fund
Corporation was not doing the modeling but providing the
return assumptions and the statutory return assumptions to
be used in the modeling. It was expected that the PF would
not manage to the model. If an adjustment was needed it
would be at the direction of the legislature. The Permanent
Fund Corporation did not dictate how much money should be
in the fund or how it was spent. It took direction from the
legislature.
3:03:45 PM
Representative Guttenberg conveyed that discussions had
been going on about the management of the PF to meet the
state's budget level.
Commissioner Hoffbeck mentioned hearing two complaints most
frequently about the governor's plan relating to the
dividend. First, it changed the value of the dividend.
Second, the volatility was transferred to the dividend even
though it created a sustainable draw for government. He
believed that the concerns were addressed in slide 26: "How
to Handle the Dividend: Historic Dividends." He noted that
the dividend had always been volatile never having had a
fixed price. Over a period of the previous 12 years the
dividend reached over $1500 on 4 occasions, between $1000
to $1500 on 4 occasions, and below $1000 4 times. He
furthered that the dividend would continue to be volatile
in the future, no matter the formula. He pointed out that
the dividend had been high for the previous 2 years: $1800
dividend 2 years previously and the highest dividend ever
in the prior year. The median payout over the 34-year life
of the dividend was about $1000. The average payout was
$1140. He also noted that the dividend payout had only
reached above $2000 twice in 34 years. Secondly, the fiscal
plan included a balance of the earnings from the state's
wealth, its spending, new taxes, and the dividend.
Increasing the size of the dividend would decrease the
amount of earnings that could be used for government
services which would require more new taxes or additional
reductions. He reiterated that a $2000 assumption of the
dividend payout was not consistent with historic data.
3:06:41 PM
Commissioner Hoffbeck advanced to slide 27: "How to Handle
the Dividend: The current formula distributes 50% of
realized gains." He relayed that the dividend was generated
by a formula. The constitution stated that all of the PF
earnings were to be deposited into the general fund unless
otherwise provided by law. The earnings have always flowed
out of the dividend and made accessible. The current law
provided that the earnings were to be used for 4 things:
dividend payments, inflation-proofing the corpus, earnings
reserves, or savings. The funds in the earnings reserve had
always been available for appropriation. The legislature
created a stable and durable circumstance by following the
rules established by a legislature 35 years previously.
Vice-Chair Saddler had heard criticism from some Alaskans
that the legislature had "Spent like drunken sailors, spent
every dollar available to them." He thought the information
that Commissioner Hoffbeck had presented made it clearly
evident that the legislature had been prudent with the
large influx of revenue, spending only half of it and
saving the other half. Commissioner Hoffbeck responded,
"Absolutely."
Representative Edgmon commented that with the downturn in
oil revenues there would be a shrinkage in the overall
gross domestic product of Alaska. He wondered if any of the
modeling pointed to a decrease in Alaska's population
resulting in an increase in dividend payouts in the future.
Commissioner Hoffbeck commented that in doing the modeling
the DOR considered that there would likely be a decline in
population in future years.
Representative Gara referred to the previous page where the
commissioner talked about the historical average of the
dividend being about $1100. He relayed that for most of the
life of the dividend the PF balance had not been at $50
billion. He did not feel it was fair to factor in years
when the PF did not have a high balance.
Attorney General Richards made the point that no one
expected investment returns such as in the '80s and '90s.
The historic growth of the fund was over 9 percent during
that time. Currently the projection was 6.9 percent.
3:10:08 PM
Commissioner Hoffbeck explained the current dividend
formula. The state took a 5-year average of the statutory
net income (using a 21 percent figure) that flowed into the
ERA. Half of the 5-year average was taken to pay the
dividend. In using the previous year's numbers the balance
of the PF was $13 billion times 21 percent equaled $2.7
billion. Half of $2.7 billion or $1.4 billion was
transferred from the ERA into the dividend fund. After
adjustments the dividend fund was divided by the number of
eligible applicants, more than 644,000. Individuals
received a check for $2072 [in 2015]. It was a
legislatively derived formula from 35 years previously.
Commissioner Hoffbeck turned to slide 28: "APFC Board
Resolution 03-05."
"The Board recognizes that … a POMV spending limit
methodology … may necessitate changes to … the
Permanent Fund Dividends"
Commissioner Hoffbeck concluded that people began to
recognize that once earnings were used in any fashion the
dividend payout would change. The formula, inputs, or both
would change along with the payout. The earnings reserve
would have to be used in some portion to fund government
services. If a person allowed for the fact that some of the
earnings would be used going forward, then the dividend
formula would change no matter what.
Commissioner Hoffbeck pointed to slide 29: "How to Handle
the Dividend." He relayed that the governor's proposal tied
the dividend to royalties, 50 percent of Alaska's ownership
share in oil revenues. It connected the dividend to the
success of the state and tied Alaskans to the economy. As a
resource state the better it was doing with resource
development the better for the state. The dividend would
increase or decrease according to what the state could
afford to pay by tying it to the royalty. The state could
also payout a flat dividend of $1000 or $1200 dividend
going forward. It would just change the amounts of the
other components. He reported that $1000 dividend would
equal about $650 million per year based on Alaska's current
population. Compared to the 50 percent royalty dividend, it
would drop the state's sustainable draw by about $200
million per year.
Co-Chair Thompson asked for a report on what had been the
royalty value over the previous 10 years. Commissioner
Hoffbeck would provide the information.
3:14:18 PM
Representative Wilson asked about the connection of the
dividend to the state's success. She wondered why the
state's success was not related to its spending.
Commissioner Hoffbeck replied that was his third option not
listed on the slide. The state could tie the size of the
dividend to the fixed draw linking it to state spending.
Representative Wilson interjected that her question had to
do with why the success of the state was not connected to
its spending. Commissioner Hoffbeck suggested that to some
extent he felt that as part of the plan state spending had
to drop. The budget could not be balanced by only taking
one element of the plan, but rather all three: cuts,
revenues, and the use of the earnings reserve.
Representative Wilson agreed that the state could not rely
solely on oil revenues. She thought there were sustainable
numbers with the right size of government down to $4
billion or $4.5 billion. She was hearing more about
generating new revenue rather than controlling state
spending. She opined that a balance between revenue and
spending was lacking. She did not believe the reduction of
$100 million was enough. She wondered if there were any
formulas being discussed having to do with the state's
spending levels.
Co-Chair Thompson reported that the subcommittees would be
coming back to the finance committee with suggested
sustainable spending levels. Additional revenues were the
current focus.
Commissioner Hoffbeck opined that the APFPA started with
determining the sustainable draw. The other targets would
be decided once establishing the draw amount. The
administration had $1 billion dollars to account for to
balance the budget. He suggested that the discussion would
become about reducing the size of government or a
combination of that and generating new revenues.
Attorney General Richards invited members to consider the
options on slide 30: "Periodic Review." He thought he had
already covered the key points and would move to the next
slide. He added that a periodic review was a good idea
regardless of what plan was decided upon.
3:18:02 PM
Attorney General Richards scrolled to slide 32: "Government
Spending & the Economy." He suggested that the state's
current situation was due to the volatility of commodity
prices and perhaps long-term declines in oil production. He
relayed that there were other oil-based economies such as
Africa, the Middle East, Wyoming, and Alberta that were
experiencing similar types of issues that Alaska was
encountering. He wondered how to have a sustainable,
predictable, rational budget when 70 percent to 90 percent
of revenue was based upon a commodity that could jump 50
percent in price from year-to-year.
Attorney General Richards noted that recently there had
been a significant amount of academic and other literature
available on how to address the problem. He reported that
in October the International Monetary Fund finalized a
report that compared 85 economies over 3 decades. It was
determined that the devil was pro-cyclical spending. The
state needed to address its pro-cyclical spending; the way
in which commodity-based economies tended to spend more on
government at times when commodity prices were high and the
economy was doing well. There were typically large capital
budgets, growth in operating budgets, and growth in other
service budgets. At times when commodity prices fell
without a designed fiscal system to handle the fall capital
budgets were reduced and operating budget growth was clawed
back. The report stated that for economies that were able
to design rules-based systems or diversified their revenue
bases through other forms of taxation to address the
commodity rollercoaster, the net result was an increase in
.3 percent year-to-year GDP growth - a huge number. If
there were booms and busts in an economy accompanied by
contraction in investor confidence, consumer confidence,
and governmental spending, an economy's long-term growth
would be hampered significantly.
3:20:54 PM
Attorney General Richards turned back to slide 16: "Rule-
Based Fiscal Policy" referring to it as his capstone. He
explained that the slide talked about some of the factors
the administration believed the legislature should consider
if the state was going to adopt an endowment model that
spent PF earnings in a way other than paying dividends. He
framed the policy in terms of rules. In looking at Alaska's
history and hearing from Mr. Rietveld who testified about
sovereign wealth funds, the administration found that the
critical components that made the legislature so
disciplined with the PF were rules-based systems and
customs that were in place defining when the PF money could
be spent. Following the rules-based systems the Alaska
Legislature had done an amazing job by always inflation-
proofing the fund (even though it was not constitutionally
mandated), methodically following a dividend payout formula
(also not constitutionally mandated), and never tapping the
earnings reserve in an ad-hoc manner to pay for a capital
project or to make up some short-term budget shortfall
(even in the '90s when it needed to). It showed incredible
discipline for a body to follow a rules-based system if the
rules were well defined. Even though inflation-proofing, a
dividend payout, and no ad-hoc spending were a result of a
majority vote. The legislature had followed the rules-based
system for the previous 30 plus years. The governor's plan
hoped to take the current-rules based system and modify it
to a slightly different rules-based system that maintained
the equal level of respect and custom by the legislature
even though it was subject to an appropriation of a
majority vote going forward, much like the old PF system.
Attorney General Richards continued that when thinking
about the proposed plan he encouraged members to consider
the rules for addressing each problem. The first problem
had to do with whether the proposal had a way to remove the
roller coaster consequences to the budget and to the
economy associated with oil price volatility. The
governor's plan accomplished this by placing production
taxes and royalties into the PF and by having a fixed
amount withdrawn as an annuity. There were other ways such
as a spending rule or some other mechanism that might be
used to similarly or differently address volatility. He
thought the question should be about how the plan addressed
volatility. The second rule was a new spending rule. If the
state was going to draw funds out of the PF to go to the GF
then a rule was needed such as a POMV or a fix-based
system. He reasoned that many different rules were
defensible, but having a rule was critical.
Attorney General Richards reviewed the third rule. The
savings rule would be different depending on the plan. The
baseline would always be 25 percent of royalties because it
was constitutionally mandated. There were also other ways
of having savings included. He provided an example from the
governor's plan which would include additional taxes and
royalty revenues into the PF. The fourth rule, the growth
rule, required sustainability. In looking at different
proposals to use the PF, sustainability needed to be an
important factor. In other words, the long-term growth of
the PF needed consideration for each of the potential plans
under evaluation. Under the governor's plan growth had to
be at least at a level equal to inflation-proofing. The
final rule he encouraged members to look at were protection
rules. He asked what rules-based system would be in place
to prevent ad-hoc rates. The current system and the
governor's system were similar because in both plans there
was a constitutional protection of the corpus, a statutory
rules-based protection, and a custom built around the
earnings reserve. He thought that the 5 rules in the slide
provided a good framework to assist legislators in thinking
about and comparing different proposals to tap the PF
earnings.
3:25:58 PM
Attorney General Richards referred to slide 36: "Delay will
. . ."
Delay will . . .
· Risk the sustainability of an endowment plan
· Reduce the sustainable draw
· Risk a downgrade of Alaska's credit rating
· Damage Alaska's economy
Attorney General Richards told the committee that the slide
was included at Representative Edgmon's request. He
reported that particular question posed to the
administration was whether there was a cost of delay. He
defined delay to be "kicking the can down the road" or not
making any decisions in the current year. He responded that
it would be difficult to quantify or capture everything
that could be affected. The administration identified 4
costs to delaying making decisions. The first he identified
as the sustainability of the endowment plan. He explained
that currently DOR projected that without making any
changes (status quo) the state would completely spend down
the CBR and the earnings reserve by FY 22. However, there
was a 20 percent chance that it could happen by FY 21
depending on the stock market performance and the price of
oil. The state would not have enough money by FY 21 or FY
22 if changes were not made to meet the state's budget
holes with the CBR and the earnings reserve. There was a 5
percent chance that the state would run out of money by FY
20. Another cost of delaying the implementation of the
governor's plan or another plan in place was that the state
would spend down more savings reducing the state's
sustainable draw. If the state waited 1 year the draw would
decrease by $100 million to $150 million. If the state
waited 3 years the sustainable draw would decrease by $400
million to $500 million.
Attorney General Richards reported that the last two costs
included the downgrade of Alaska's credit rating and the
overall damage to Alaska's economy. Both risks were more
qualitative than the first 2 items. The Department of Law
had asked the DOR to quantify the actual costs to Alaska in
terms of an increased interest as a result of any credit
downgrades. He reported that Standard and Poor's stated
that the state's credit rating would decrease if nothing
changed. Lastly, the more qualitative problem of delay was
that if investors and individual Alaskans did not see a
path forward that gleaned confidence they would likely be
less willing to invest. There could be a potential rippling
effect of higher unemployment and a drop in home values:
consequences of the economy not moving forward. A
sustainable budget was such a large part of the state's
economy. He would be providing some of the actual financial
costs in borrowing if the state was downgraded.
3:30:07 PM
Representative Edgmon appreciated the slide. He thought it
captured the macro factors involved with kicking the can
down the road. He was most concerned with the fourth item,
damaging Alaska's economy. He wanted to hear more about
item four and suggested also hearing from people from the
private sector about damaging Alaska's economy. It was new
for the legislature to have to entertain such a drastic
level of new revenues, budget reductions, taxes, and all of
the pejorative things imaginable in an election year. He
thought it to be a watershed proposition if the legislature
were to endow an endowment plan. He wanted to hear
additional comments on how delay would damage Alaska's
economy.
Co-Chair Thompson remarked that there would be more
detailed vetting of the bill along with others in the
future.
Vice-Chair Saddler referred to the governor's comment about
how the plan was written in pencil rather than in ink. He
asked how much of the bill (HB 245, version A) was in ink
and in pencil. He wondered how committed the governor was
to each element of the plan or to the general concept. He
noted that there were competing concepts.
Attorney General Richards responded that the administration
and the governor were committed to the plan and thought it
was the best plan in terms of addressing the issues listed
on his capstone slide (growth, volatility, protection, and
spending rules). He suggested that at the end of the day it
was the legislature's prerogative to adopt a bill they
thought was best. He added that the administration would
work with the legislature to come to a compromise that
addressed all the items on the capstone slide. Both the
governor's plan and a POMV plan worked under any PFD
formulation. The dividend could be set at any level. Future
dividends could be based on a number of calculations which
would be part of the dialogue. At the end of the day the
consequence would be how much could be taken from the
system for GF spending.
Vice-Chair Saddler asked if there were any elements of the
bill that, if not passed into law, the Attorney General
Richards would advise the governor to veto.
Attorney General Richards had not had such a dialogue with
the governor.
HB 245 was HEARD and HELD in committee for further
consideration.
Co-Chair Thompson indicated there would be additional
hearings on HB 245 and a sectional analysis would be
provided for review. He conveyed the agenda for the
following day.
ADJOURNMENT
3:34:32 PM
The meeting was adjourned at 3:34 p.m.
| Document Name | Date/Time | Subjects |
|---|---|---|
| HB 245 - Alaska Permanent Fund Protection Act (Feb 15 2016 HF).pdf |
HFIN 2/15/2016 1:30:00 PM |
HB 245 |
| HB 245 NEW FN DOA VCCB 2-15-16.pdf |
HFIN 2/15/2016 1:30:00 PM |
HB 245 |
| HB 245 - Dividend comparison - response to HFIN (2 25 16).pdf |
HFIN 2/15/2016 1:30:00 PM |
HB 245 |