02/09/2004 08:12 AM Senate JUD
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ALASKA STATE LEGISLATURE
SENATE JUDICIARY STANDING COMMITTEE
February 9, 2004
8:12 a.m.
TAPE(S) 04-4&5
MEMBERS PRESENT
Senator Ralph Seekins, Chair
Senator Gene Therriault
Senator Hollis French
MEMBERS ABSENT
Senator Scott Ogan, Vice Chair
Senator Johnny Ellis
COMMITTEE CALENDAR
SENATE BILL NO. 300
"An Act relating to an attorney's lien, to court actions, and to
other proceedings where attorneys are employed."
HEARD AND HELD
SENATE JOINT RESOLUTION NO. 18
Proposing amendments to the Constitution of the State of Alaska
relating to limiting appropriations from and inflation-proofing
the Alaska permanent fund by establishing a percent of market
value spending limit.
HEARD AND HELD
SENATE JOINT RESOLUTION NO. 19
Proposing amendments to the Constitution of the State of Alaska
relating to the Alaska permanent fund.
HEARD AND HELD
PREVIOUS ACTION
BILL: SB 300
SHORT TITLE: ATTORNEY'S LIEN
SENATOR(s): STEDMAN
02/06/04 (S) READ THE FIRST TIME - REFERRALS
02/06/04 (S) JUD, FIN
BILL: SJR 18
SHORT TITLE: CONST. AM: PF APPROPS/INFLATION-PROOFING
SENATOR(s): RLS BY REQUEST OF LEG BUDGET & AUDIT BY REQUEST
04/17/03 (S) READ THE FIRST TIME - REFERRALS
04/17/03 (S) STA, JUD, FIN
05/01/03 (S) STA AT 3:30 PM BELTZ 211
05/01/03 (S) Heard & Held
05/01/03 (S) MINUTE(STA)
05/06/03 (S) STA AT 3:30 PM BELTZ 211
05/06/03 (S) Moved CSSJR 18(STA) Out of Committee
05/06/03 (S) MINUTE(STA)
05/07/03 (S) STA RPT CS 1DP 3NR NEW TITLE
05/07/03 (S) NR: STEVENS G, DYSON, GUESS;
05/07/03 (S) DP: COWDERY
05/13/03 (S) JUD AT 8:00 AM BELTZ 211
05/13/03 (S) Scheduled But Not Heard
05/14/03 (S) JUD AT 0:00 AM BELTZ 211
05/14/03 (S) -- Meeting Postponed to 5/15/03 --
05/15/03 (S) JUD AT 8:45 AM BELTZ 211
05/15/03 (S) -- Meeting Rescheduled from 5/14/03 --
10/28/03 (S) JUD AT 7:00 PM Kenai
10/28/03 (S) CONST. AM: PERMANENT FUND INCOME
10/29/03 (S) JUD AT 7:00 PM Mat-Su LIO
10/29/03 (S) CONST. AM: PERMANENT FUND INCOME
10/30/03 (S) JUD AT 7:00 PM Anch LIO
10/30/03 (S) CONST. AM: PERMANENT FUND INCOME
01/21/04 (S) JUD AT 8:00 AM BELTZ 211
01/21/04 (S) -- Meeting Canceled --
BILL: SJR 19
SHORT TITLE: CONST. AM: PERMANENT FUND INCOME
SENATOR(s): LINCOLN, Ellis
05/02/03 (S) READ THE FIRST TIME - REFERRALS
05/02/03 (S) STA, JUD, FIN
05/13/03 (S) STA AT 3:30 PM BELTZ 211
05/13/03 (S) Moved Out of Committee
05/13/03 (S) MINUTE(STA)
05/14/03 (S) STA RPT 1DP 3NR
05/14/03 (S) NR: STEVENS G, COWDERY, DYSON;
05/14/03 (S) DP: GUESS
05/16/03 (S) JUD AT 1:00 PM BELTZ 211
05/16/03 (S) Scheduled But Not Heard
05/17/03 (S) JUD AT 10:00 AM BELTZ 211
05/17/03 (S) Heard & Held
05/17/03 (S) MINUTE(JUD)
10/28/03 (S) JUD AT 7:00 PM Kenai
10/29/03 (S) JUD AT 7:00 PM Mat-Su LIO
10/30/03 (S) JUD AT 7:00 PM Anch LIO
01/21/04 (S) JUD AT 8:00 AM BELTZ 211
01/21/04 (S) -- Meeting Canceled --
WITNESS REGISTER
Senator Bert Stedman
Alaska State Capitol
Juneau, AK 99801-1182
POSITION STATEMENT: Sponsor of SB 300
Mr. William Schendell, Attorney
Fairbanks, AK
POSITION STATEMENT: Supports SB 300
Mr. Ken Covell, Attorney
Fairbanks, AK
POSITION STATEMENT: Supports SB 300
Ms. Jo Kuchle, Attorney
Fairbanks, AK
POSITION STATEMENT: Supports SB 300
Mr. Kevin Walsh, CPA
Fairbanks, AK
POSITION STATEMENT: Supports SB 300
Mr. Robert Storer
Executive Director
Alaska Permanent Fund Corporation
PO Box 25500
Juneau, AK 99802-5500
POSITION STATEMENT: Answered questions regarding SJR 18
Representative Eric Croft
Alaska State Capitol
Juneau, AK 99801-1182
POSITION STATEMENT: Presented SJR 19 for Senator Lincoln
Mr. Mark Stopha
Staff to Senator Lincoln
Alaska State Capitol
Juneau, AK 99801-1182
POSITION STATEMENT: Available to answer questions about SJR 19
Mr. Roger Gay
Big Lake, AK 99652
POSITION STATEMENT: Opposed to inflation proofing the permanent
fund
Mr. Gary Hanthorn
Wasilla, AK 99654
POSITION STATEMENT: Supports keeping the permanent fund dividend
program
ACTION NARRATIVE
TAPE 04-4, SIDE A
CHAIR RALPH SEEKINS called the Senate Judiciary Standing
Committee meeting to order at 8:12 a.m. Senators Therriault,
French and Chair Seekins were present. He announced that
Senators Ellis and Ogan would not be attending the meeting
today. The first order of business to come before the committee
was SB 300.
SB 300-ATTORNEY'S LIEN
SENATOR BERT STEDMAN, prime sponsor of SB 300, told members that
SB 300 is a housekeeping measure to avoid double taxation. He
explained that when court settlements are awarded, the
prevailing party must pay income tax on phantom income - the
gross amount of the award even though part of that income is
paid to the party's attorney. The attorney must then pay tax on
the income received, resulting in double taxation. The structure
of the system in the State of Oregon differs so that if the
proper documents are filed, the court settlement is paid to the
attorney who, after retaining attorney fees, pays the remainder
to the client, thereby avoiding double taxation. Attorneys have
structured trust accounts to hold court settlements, so this
mechanism would pose no danger to the client.
8:16 a.m.
SENATOR HOLLIS FRENCH asked for an example to illustrate the
double taxation problem.
SENATOR STEDMAN said a wrongfully damaged plaintiff might be
awarded $10,000. The plaintiff would have to claim income of
$10,000 and pay tax on that amount, $2,000 if the plaintiff's
tax bracket was 20 percent. The plaintiff must also pay 30
percent of the $10,000 for attorney fees, equaling 3,000. Then,
the attorney must pay tax on his fee of $3,000. SB 300 will
avoid double taxation by paying the attorney off the top, so
that the plaintiff would claim gross revenue of $7,000.
SENATOR FRENCH surmised that two parties would be paying income
tax on the $3,000.
SENATOR STEDMAN said that is correct. He said there is no way an
attorney could avoid paying taxes on his or her fees, so SB 300
will not affect the attorney. It will, however, have a big
impact on the citizen who must pay tax on the attorney fees.
SENATOR GENE THERRIAULT asked if the way to avoid double
taxation is to have the attorney file the proper lien paperwork
so that the jury award becomes the property of the attorney.
Then, once the attorney's lien is paid, the remainder is paid to
the client via contract.
SENATOR STEDMAN said that is correct and that the client would
pay taxes on the actual amount paid to him or her. He clarified
that the award funds paid to the attorney would be protected by
a litany of regulations to provide safety for the client.
SENATOR THERRIAULT asked if SB 300 passes, the plaintiff in the
previous example would receive $7,000 and the attorney would
receive $3,000, while under the current system, the plaintiff
would only receive $5,000.
SENATOR STEDMAN said that is correct.
SENATOR FRENCH asked if any damage award would go directly to
the attorney.
SENATOR STEDMAN said yes, if the attorney has filed the proper
liens, and the attorney would disburse the funds directly to the
client. The plaintiff would then claim only the income received
from the attorney, not the gross amount.
SENATOR FRENCH noted letters of support from attorneys in
members' files but asked if Senator Stedman has heard from any
plaintiffs who are concerned that attorneys might sit on their
money for too long.
CHAIR SEEKINS said that witnesses were available to testify and
might be able to answer that question. He took public testimony.
MR. WILLIAM SCHENDEL, an attorney who has practiced in Fairbanks
for about 30 years, told members that the issue behind SB 300 is
double taxation and is one of the biggest problems that has
faced both employers and employees over the last five years. In
essence, the plaintiff is taxed on the attorney fees that the
plaintiff does not receive. The consequence of that system is
that the plaintiff is prompted to try to recover more from the
defendant, typically the employer, and that drives up the cost
of settlements. SB 300 will do away with double taxation so that
the plaintiff is only taxed on the net award.
MS. JO KUCHLE, a Fairbanks attorney for 17 years, told members
that regarding the trust account issue, the funds do not always
flow through the trust account; sometimes the funds are paid
directly to the prevailing party. She said under the current
scheme this issue not only arises with settlements, it can occur
with judgments or in any case in which the prevailing party has
won damages and pays attorney fees. She pointed out:
This has been primarily the result of rulings by the
Ninth Circuit Court of Appeals, which has basically
determined that for federal tax purposes, the fee
award, though it goes directly to the taxpayer and the
taxpayer has to pay the attorney, gets taxed entirely
to the taxpayer. They carved out an exception in
Oregon on Oregon's lien law. That's why the group
before you has requested, and we're very pleased that
Senator Stedman has introduced this bill, to correct
this disparity with Oregon taxpayers and that all
taxpayers really in the Ninth Circuit - all states in
the Ninth Circuit are affected by this taxpayer
[indisc.].
MR. KEN COVELL, a Fairbanks attorney for 18 years, told members
he focuses on personal injury and employment law, and that he is
concerned that in civil rights actions, a plaintiff will receive
nominal damages of $1. However, attorney fees are often
$100,000. These cases are often very important and involve
racial discrimination. It is conceivable that a plaintiff could
receive a $1 award but have a $30,000 tax liability because of
the $100,000 attorney fee. He pointed out that clients often
take on such cases at great emotional and personal risk.
Therefore, if an attorney has to tell that client he or she is
liable for an additional $30,000 tax, clients will not pursue
important cases. SB 300 would put the citizens of Alaska on
equal footing with citizens of various other states. He repeated
that the current system creates a disincentive for clients to
pursue important issues.
MR. KEVIN WALSH, a certified public accountant in Fairbanks for
25 years, thanked members for considering SB 300. He said this
issue is near and dear to him as he runs into this problem in
his tax practice and must advise potential plaintiffs. It
creates different classes of taxpayers and affects opportunities
that people have to correct injustices changes based on tax
advice. He considers that to be wrong and looks to SB 300 for
resolution. He said this issue is based on federal income tax
law, which is based on taxing the owner of income. A recent
Supreme Court decision basically said, "tax the fruit of the
tree to the tree from which it falls." This lien law is based on
establishing property rights - who owned the case and who owned
what right under the case. Current federal tax law says the
entire case belongs to the plaintiff; therefore all amounts
flowing from that case are taxable to the plaintiff. He
explained:
Then, if the plaintiff is allowed a deduction for the
amount of the attorney fees that they pay, then they
end up [indisc.] income tax only on the net amount.
This is absolutely true for any business that is
successful in a suit. Businesses report the entire
damage amount as income, deduct all of the attorney
fees. They only pay income tax on the net amount.
People that are injured in a personal injury situation
don't pay taxes at all. This is not an issue for them.
So it boils down to the only people impacted on this
are the employees. Employees who bring suit against
their employers for whatever reason and end up
successful, end up having to report the entire amount
of the attorney fees and their own award as income.
They are then allowed a deduction for the amount that
they pay the attorneys.
Unfortunately the deduction is limited to two separate
distinct events: one, it is only allowed as a
miscellaneous itemized deduction and limited to the
amount that exceeds 2 percent of their adjusted gross
income.... Unfortunately, the alternative minimum tax,
which if you have - is a parallel tax system that was
established many years ago to make sure that the rich
paid at least a minimum tax every year, the
consequence of that tax is that no miscellaneous
itemized deductions of any type are allowed for
purposes of computing that tax and then the tax rate
is 25, 28 percent applied to the net income coming
from that.
So let me give you a real live example coming out of
our practice. We had a public interest litigant, an
employee who was [indisc.]. They sued successfully.
The received approximately $105,000. Their attorney's
fees were $100,000 and that was understood to be part
of the award. In other words, their net amount was
about $5,000. They ended up with a tax bill associated
with that of approximately $30,000. In other words,
understand, they got to keep $5,000 and had the
obligation to pay $30[,000], so by taking corrective
action through the judicial system to get a court to
correct an employer's egregious behavior, they had to
reach in their pocket and take out approximately
$25,000. I consider that to be a miscarriage of
justice.
MR. WALSH gave other examples and said that the origin of this
situation is based on property law in Alabama, Michigan and
Oregon. The court reviewed it and found the attorneys in those
cases had a sufficient property right in their piece of that
case so that income was taxed to them and not to the taxpayers.
The Alaska Supreme Court has reviewed this issue and said the
person receiving the award "gets the shaft." He said Alaska's
law should be changed so that a public interest litigant is not
penalized. He noted the Supreme Court has had several
opportunities to correct the disparity between the circuit court
and has basically said it does not care. Similarly, Congress has
had the opportunity to take this matter up several times but
declined to do so. He encouraged the Legislature to take action.
8:37 a.m.
CHAIR SEEKINS asked, "As I understand it, this lien exists until
it is satisfied and only affects the previously agreed upon
fees. Is that correct?"
MR. COVELL said that is correct.
CHAIR SEEKINS asked if SB 300 passes, the prevailing party would
pay taxes only on the award less the attorney fees.
MR. COVELL agreed.
CHAIR SEEKINS asked if SB 300 will correct the current
disparity.
MR. COVELL said it would.
CHAIR SEEKINS asked if it would have any fiscal impact on the
State of Alaska.
MR. COVELL said it would not.
SENATOR THERRIAULT asked if attorney fees and the costs of a
case are categorized separately and whether they would be
treated the same way.
MR. COVELL said he believes so; nothing would change in regard
to cost.
CHAIR SEEKINS said as is the common practice of the committee,
he would hold the bill for a second hearing to see if anyone
else wants to comment. He said he believes SB 300 is good public
policy and thanked all participants.
[The following is a verbatim transcript.]
SJR 18-CONST. AM: PF APPROPS/INFLATION-PROOFING
CHAIR RALPH SEEKINS: Okay, next we're going to move on to our
second item, which is CSSJR 18[STA]. We're looking at version
[H]. A little bit of history on this bill - we have had public
hearings across the state. We had public hearings this summer in
Fairbanks; we had public hearings in Kenai, in Mat-Su and in
Anchorage. Today is our last opportunity for public hearings on
this particular bill and then for any questions from the members
that are present. Do we have anyone who would like to testify
today on CSSJR 18? I see Mr. Storer is here from the [Alaska]
Permanent Fund [Corporation] and I think the members pretty much
understand what the proposal is here. Is there anything that you
would wish to add to what you guys have testified on already
four times across the state?
MR. ROBERT STORER, EXECUTIVE DIRECTOR, ALASKA PERMANENT FUND
CORPORATION: Thank you Mr. Chair. We're prepared to answer any
questions that you may have.
CHAIR SEEKINS: We'll hold you to stand by for any questions. Is
there anyone on-line that would like to testify on this bill?
[No response.] Anyone in the audience that would like to testify
on CSSJR 18? [No response.] Mr. Storer, perhaps you could take
the chair in case we do have any questions from members of the
committee? Anyone signed up Mr. Hove? [No one signed up.] At
this point, we're going to close public testimony on this CS for
SJR 18. Public testimony is closed. Questions from the members -
any questions, comments? Here's our opportunity to ask the
expert as to what the formula that they originated from the
trustees of the permanent fund is in this resolution that we're
considering today. Senator Therriault?
SENATOR THERRIAULT: Mr. Storer, I know one of the concerns that
has come up is that with the allowable up to five percent draw,
there could be some erosion of the principal in a down
investment market or climate. I know that you have run some
models historically looking back to see [indisc.] toss around
some different ideas of how we could prevent that from
happening. I'm wondering if you could just go over that?
MR. STORER: Thank you, Mr. Chair. I'm Bob Storer, the Executive
Director of the Alaska Permanent Fund Corporation. Senator
Therriault, I have handouts from two views if I could ask that
those be distributed? We take the longer term view so the first
thing we looked at was what was the real rate of return based on
a 10-year rolling average of the history of the fund. And if you
look at that, you'll see that in all time periods - I should
describe the chart - zero and above is the excess return -
earnings of the fund above inflation so zero and below would
incorporate inflation. This is zero and above is the real rate
of return of the permanent fund. And then we've driven a red
line through the 5 percent real rate of return because, of
course, that's our proposed constitutional amendment.
You'll see on a rolling 10-year period, during all time frames,
we have been able to achieve a 5 percent real rate of return and
that includes the most recent period where we experienced not
only very high rates of return in the bull market but a 3-year
bear market as well. In fact, we earned a 5.3 percent real rate
of return for that 10-year period and you'll see it's trending
back and we've extrapolated what we think we'll earn through
this whole fiscal year.
So that's one way of looking at it. But many people have said
well what happens, you've got - it's on a rolling 5-year rate of
return, so what happens if you look at a 5-year rolling rate of
return perspective and you'll see I've also provided a graph for
you on that as well. And you'll note that in virtually all
periods we have earned an excess rate of return of 5 percent
real, with the exception of most recent history when we had the
3-year bear market and you'll see that over those 5-year
observations most recently, we still were able to achieve a real
rate of return, albeit below 5 percent, slightly above probably
about 1 percent, etcetera. Now it's trending upwards because the
returns have been so good over that period. This chart
highlights what I believe is the importance of the POMV, which
is limiting or creating the discipline to not overspend in the
good years. If you look at that chart, by not overspending, and
the legislature did not, they created the cushion, the reserves
that actually would allow us to meet, or allow decision makers
to meet, the payments in the down years. So I think this chart
illustrates, in my mind, the importance of the discipline in the
good years to create a reserve for the down years.
CHAIR SEEKINS: Go ahead Senator Therriault.
SENATOR THERRIAULT: Just so I can make sure I understand this -
so the zero line incorporates covering inflation?
MR. STORER: Correct.
CHAIR SEEKINS: Senator French?
SENATOR HOLLIS FRENCH: Mr. Storer, I had a conversation with Mr.
Bartholomew this summer and I explained my chief reservation
about this proposal and that is in the same area that I think
Senator Therriault was just asking about and that is the
inflation proofing. The quarterly report you guys mailed out to
me at my home late in the summer, early September, showed that
the annualized 5-year return for the years ending June 30, 2003,
that is going back 5 years from there, the total fund returned
3.39 percent. That's the kind of scenario I guess that most - at
least I am concerned about, that we could go into a time that
we're not making a lot of money and we're taking this 5 percent
out and you start to claw into the fund. I think that really
sort of highlights one of the difficulties in the proposal, and
that is that if you really believe you can take out 5 percent
regularly, after inflation proofing, and if one of the chief
selling points of the model is that it provides a predictable
payout, that is somewhat undercut by the idea that, well, you
don't have to take that 5 percent in bad years. I think that's
one of the faults, if you will, in the premise of the POMV is
that you're going to have this predictable 5 percent payout
except in bad years when you don't do that. Once I think you go
to telling folks you're going to have a 5 percent payout, it's
going to be very, very difficult to take something less than 5
percent. So I guess my concern is that in bad years, in years
where you get a 3.39 percent annualized return, you haven't made
your 5 percent and you haven't inflation proofed either. That
strikes me as clawing into the principal of the fund.
CHAIR SEEKINS: Let me ask a couple of questions so that we can
take a look at this when we talk about this. You know I've been
a used car salesman for a long time. What's the present market
value of the fund, roughly?
MR. STORER: It's in excess of $27 billion right now.
CHAIR SEEKINS: Okay, so we've got 27 billion. What's the
principal of the fund?
MR. STORER: That's - I was afraid you were going to ask me that.
I've been traveling so much but I think it's about $22.5
billion.
CHAIR SEEKINS: So with that in mind, we've got $4.5 billion in
market value that exceeds the current principal value of the
fund?
MR. STORER: Um-hum.
CHAIR SEEKINS: So we'd have to have a couple of really bad years
before we started eating into the principal if we started now
with a 5 percent payout - is that correct?
MR. STORER: That is correct.
CHAIR SEEKINS: So there's a cushion already there that exists
because of the discipline of the legislature in the past and so
we should not confuse market value as principal - am I correct
there Mr. Storer?
MR. STORER: I think that's an important issue. I think you've -
in my mind, I'd like to address a couple of things there.
Everywhere I've seen in the United States over the last - as a
result of the bear market, is everyone got caught overspending.
Not everyone, but I can cite you example after example of
overspending in the good years - they got caught up in the bull
market mania. I believe the best way - this is what I believe
personally, I believe it strongly - the best way to protect the
principal is to create the discipline not to overspend. If I add
some responses to Senator French's comments, I've thought about
that a lot over the summer because I know it's important not
just to you but to many people, and my response has always been
as it relates to the POMV, and again I send you to the 10-year
period, which says that in fact, we have been able to achieve
that goal but we well may not in the future.
The problem exists under the current system as well and we can't
forget that. So then it becomes each system has a set of
decisions or parameters around it based on the statutes, or the
guidelines, or what matters. You are correct, if decision makers
wished in a low real rate of return period to distribute 5
percent, we say the stability, the predictability - it's there
or it's not there. Under the current system, and you know we
have varying scenarios, we had a real rate of return there -
what happens if we get a negative real rate of return? Under the
current system, depending, you have the same problems but you
can also hit that principal and theoretically go several years
without any payment at all. Then you've got this 22 - 27 billion
dollar fund that does nothing until the market value goes back
above. And so it's a decision. It's an important decision. One
gives you the flexibility. The other, in a really bad scenario,
you wait or you change the Constitution to eliminate principal
then. So the problem doesn't go away in either way. It just
manifests itself in a slightly different way.
CHAIR SEEKINS: And so, I see - as you know I was on the
Permanent Fund Board of Trustees and I can see all kinds of
different scenarios where even the current system could be used
to actually spend into the principal by selling losers and other
different ways to be able to do that to produce revenue into -
well it wouldn't produce revenue but we could actually spend
into the principal at this time. Is that correct?
MR. STORER: If you - on the current, you can take income - if
realized income is available you can distribute that. So if you
had realized income and then unrealized losses, you could pay
out and then the value of the fund would be below principal, as
an example.
CHAIR SEEKINS: What do we do with rents and royalties? Where do
we classify those?
MR. STORER: Those are realized income.
CHAIR SEEKINS: So we could be losing in the market and not sell
it because that's unrealized losses.
MR. STORER: That is correct.
CHAIR SEEKINS: And be bringing in rents and royalties that we
call realized income and that goes to distribution even though
we're losing our shirt in the markets?
MR. STORER: Under the current system that's correct, Mr.
Chairman. And the other question in all of this is, under the
current system is would inflation proofing continue or not. It
always has in the past through the statutory process.
CHAIR SEEKINS: I always ask the question on that - if I was
looking at my own family, you know, the question I ask is would
I inflation proof it if I couldn't feed my kids? Easy decision
but if I look at this then, if I understand my math was wrong as
I look at it, $27 billion market fund - market value, $22.5
[billion] principal - that's $4.5 billion between principal and
market value. If we were taking 5 percent of that market value
now, it would take us three years to get down to principal?
MR. STORER: If we didn't earn anything.
CHAIR SEEKINS: If we didn't earn anything, so there's a cushion
that's there and I don't think a lot of people in the state
understand that that cushion exists because they only think in
terms of the market value, not the principal value.
MR. STORER: At one time, Mr. Chair, 25 percent of the fund was
either realized income or unrealized gains, in about 1999, early
2000.
CHAIR SEEKINS: Okay. Senator French?
SENATOR FRENCH: But my understanding is when you enact the POMV,
you eradicate that difference. As soon as you enact POMV, you
stop thinking about principal and earnings. You make one big pot
of money, and it's going to be about $27 billion and from that
day forward, Alaskans are going to regard that as their
permanent fund and they're not going to differentiate between
what it's earned and what it hasn't earned. And I think from
that day forward, we're going to have to give them some
reasonable and, I think, explicit promise of inflation proofing.
If these models hold true, then for us to write inflation
proofing in the Constitution is no risk at all to the fiscal
stability of the state. But, if I can finish, I have concerns
about whether this model is going to hold true over the long
run. We haven't seen a crushing period of inflation for some
time now, not since the late '70s and early '80s. The first
president I ever voted for was Jimmy Carter. Then I moved to
Alaska and found out what a bad idea that was from many
Alaskans' point of view. And during that time period, there was
terrible, terrible inflation and I think, given the federal
deficits that are being run up here in this country, the largest
ever in the history of the nation, sooner or later the bond
market is going to have to react to that and I think interest
rates are going to have to go up. And so I'm just concerned that
unless we put some positive guarantee of inflation proofing on
paper - because in your system, inflation proofing is implicit
and I'd like to make it explicit. I guess that's my chief
concern.
MR. STORER: Mr. Chair, first off I've looked at a lot of
scenarios and the worst case scenario, in either case I believe,
is, I'll call it hyper-inflation. We can handle rising inflation
to some degree but if we revisit the '70s - the '70s, like the
Depression, were the two very singular events. Can they happen
again? Of course they can happen. That's the worst-case scenario
under either scenario. It seems to be, well, if it happens, it's
not in the foreseeable future. But the one thing I want - a
couple of elected officials have asked me to provide statutory
guidance, statutory insight that essentially addresses precisely
what you're talking about - about memorializing the guidance by
statute.
CHAIR SEEKINS: And I understand that. In fact, I would support
that. Go ahead, Senator Therriault.
SENATOR THERRIAULT: If we got into a situation like the '70s
with staggering inflation, under the current system we have a
big problem too.
MR. STORER: That's the worst-case scenario, there's no question
about it. For a long time I've run models just trying to find
what is the worst-case scenario. It gets postponed for a few
years but you would have a big issue in terms of maintaining
purchasing power and, at least historically, you would see low
returns in bonds and equities during that period as well.
SENATOR THERRIAULT: So the current system has not only the
instability of the dividend roller coaster, but it's more
susceptible to hyperinflation and the erosion that would accrue
to the fund?
MR. STORER: I believe it is. I believe it is because of that
line that it is principal that you cannot go below and there
would be - the question was - it becomes would inflation
proofing be abandoned in that scenario? I personally find it
hard to believe it would not be because the only way you could
access income, or the first line would be to abandon inflation
proofing so you're no longer maintaining your purchasing power
anyway.
SENATOR THERRIAULT: Mr. Chairman, it is true, as far as the
wording here, Section 3 is a one time deposit of $4.5 billion
that the legislature would be putting before the people and the
people would vote on [whether] that $4.5 billion deposit from
the earnings reserve would go into the principal, establishing a
new level for principal. So I just wanted to clarify that. But,
with regards to the 5 percent draw, the language says you may
take up to - it may not exceed 5 percent. It doesn't say thou
shalt take 5 percent each year. And, in fact, because you've got
4 or 5-year averaging, you are actually drawing off less than 5
percent. It's more like 4.75 or 4.8. Is that correct? Because
you've got a growing fund - you've got new resources that are
going in, you've got inflation proofing going in, so when you
take the 5-year average of a growing fund, it's actually less
than 5 percent of that year's market value.
MR. STORER: Through the chair, that's absolutely correct. If you
look at the snapshot of the payout versus the ending value of
the fund, it looks more like around 4 and three-quarters
percent.
SENATOR THERRIAULT: So we look back on the history. The 10-year
history shows that from a 10-year look back that we could have
paid the 5 percent and if we want additional protection, we can
consider statutory language or if somebody wants to propose or
come up with a way sensibly to put it into the Constitution, you
could have language that says if you get into a situation where
you're going to dip down below that line, then you put the
brakes on and your allowable draw is even less.
CHAIR SEEKINS: I think it's very easy for us - I always - what I
hear now - people say is well, it could erode the principal, we
could be dipping into the principal and that's why I wanted to
make it very clear that there's a $4.5 billion buffer from where
the fund is now until we get to the principal. So that, in my
mind, kind of satisfies that argument. And secondly, you know,
I'm concerned about the faults of the current system where our
growing fund causes us to overspend. We can exceed that 5
percent if we wanted to in overspending and how we do it,
including inflation proofing - inflation proofing appreciating
assets, which sometimes doesn't make that much sense to me
unless somebody else is willing to do it for me, but, when I
look at the current method, and if I try to characterize - let
me ask you a question. How many investment funds and investment
managers are just looking ... [END OF SIDE A].
TAPE 04-4, SIDE B
CHAIR SEEKINS: ... current method of handling endowment funds?
MR. STORER: Mr. Chair, the answer is not many because there are
already - rushing to our methodology?
CHAIR SEEKINS: Yes, our current methodology.
MR. STORER: 85 percent of the endowments, the universities use
some variant of what we're proposing. I'm not sure that I'm
aware of any entity that still lives off the concept of realized
income. Even accounting standards changed in the mid-'90s to
recognize that appreciation is income as well.
CHAIR SEEKINS: So we're not thinking up something new and a lot
of other financial minds have said how can we best preserve our
endowment without, you know, over the long term eroding it to
nothing? And a percent of market value methodology is what they
have found to be the best way to do that. Am I correct?
MR. STORER: That is correct and there's many examples in Alaska
that have adopted the percentage of market value payout as well.
CHAIR SEEKINS: For example?
MR. STORER: For example Anchorage. I was just talking to Senator
Stedman - Sitka. I know the University of Alaska at Fairbanks -
the foundation for years in Alaska has that methodology.
CHAIR SEEKINS: The City of Fairbanks.
MR. STORER: The City of Fairbanks has one. Bob Bartholomew in
our office, the chief operating officer, was just in Barrow and
he said that they've adopted the POMV as well. I'm not sure
whether Valdez has or not.
CHAIR SEEKINS: Okay. Senator Therriault?
SENATOR THERRIAULT: Bob, you're a fiduciary for the permanent
fund so you understand the fiduciary duty or obligation. Do you
think it would be fair to characterize that if we had POMV, and
you proposed to go to our current system, would you be
subjecting yourself to possible litigation for breaking your
fiduciary obligation - taking us to a system that is more
subject to the ups and downs of the markets and more subject to
the dangers of high inflation?
MR. STORER: I'm sorry - if we?
CHAIR SEEKINS: If we...
SENATOR THERRIAULT: The POMV.
CHAIR SEEKINS: If we had the POMV.
SENATOR THERRIAULT: And you were proposing that we go to the
system that we have currently, which is more of a roller coaster
and more subject to inflation, would you possibly be setting
yourself up for a claim that you have broken your fiduciary
obligation?
MR. STORER: One of the keys in a fiduciary is showing a process
to make an informed decision. So if I was trying to convert us
back, I would - within that obligation would be to show you a
process that why - to give you an informed decision and I don't
think I would be breaking my fiduciary responsibility. I think
it would be a real challenge though, to convert from a POMV to
realized income when you realize there's so many complexities in
terms of our equity portfolio structure and the appreciation of
those assets.
CHAIR SEEKINS: If I could reword that just a little bit then -
would recommending that someone go from a percentage of market
value process, similar to one that's been recommended, to the
current realized income, would it be in compliance with
reasonable person responsibilities? I mean you...
MR. STORER: It would be a challenge.
CHAIR SEEKINS: It would be a challenge. I'll leave it at that.
MR. STORER: But it would be - as I noted earlier, it would be
inconsistent with current accounting standards. So, one of the
challenges would be to say if current accounting standards
recognize appreciation of the assets as earnings, then why are
you saying that that doesn't matter and only realized income
matters? That would be a challenge.
CHAIR SEEKINS: So if we divorce ourselves, if we separate how
any distribution would be used from the process, the process is
the one that's most currently adopted by major endowments,
financial advisors across the nation if not the world.
MR. STORER: True, Mr. Chair. The permanent fund is about 27
years old now and if you look at our statutes - distribution,
inflation proofing, they're 27 years old. We've [indisc.]
additions to try and meet contemporary investment standards in
there but they're 27 years old. Our realized income statutes
made sense back then. I think you've all seen a slide that shows
how our asset allocation has changed. I think our objective is
to create a permanent fund that can meet the needs of the
legislature, the citizens of Alaska, and also address
contemporary investment management issues and that's what we're
trying to do.
CHAIR SEEKINS: Senator French?
SENATOR FRENCH: Thank you. Call me hard headed but I'm really
stuck on the inflation proofing issue and I think this chart
makes my point as well as it makes yours. I'm not against
modernizing the way the fund is handled, but if this model holds
true, you can write into the Constitution, you must inflation
proof the fund before distributing earnings and as long as you
are, you know, over the last five years you would have beaten 5
percent - oh, I'm sorry - back to 1994, to the beginning of this
chart, you would have beaten 5 percent every single one of those
10-year rolling averages and so you'd have exactly what you
want, which is a predictable payout, and exactly what I want,
which is concrete inflation proofing. Am I misunderstanding this
chart?
MR. STORER: No. That chart - there'll be some point where that
chart will go below the 5 percent.
SENATOR FRENCH: Sooner or later in time.
MR. STORER: Yes.
SENATOR FRENCH: It just happens.
MR. STORER: Yes. It will happen. And, if I arrived here in May
of '83 and we were having this conversation, you would say
Storer, you're crazy, you can't achieve it, so that's an example
and all of that. The question for all of you in regards to that
in my mind is predictability and stability versus that piece
then, which would eliminate some of the predictability or
stability of payout, wherever it goes. That's there in the
discussion point. And whether - how one wants to have that
decision, either have that decision taken away, have that
decision by statute, or address it every year, etcetera, that's
the debate. What we're proposing gives greater predictability,
greater stability to the payout over time, but the potential
exists that at some time you could go below what we now call
principal. The other side of the coin, the benefit, is you're
not going to overspend in the good years. So, in a perfect
world, if it happens in this environment, you've got the cushion
to where you never have to go there.
CHAIR SEEKINS: I think, as a way of comment, I think inflation
proofing is important but, as I said earlier, it's not a hard
decision for me - if I was going to inflation proof my if I
couldn't feed my kids. I think the legislature deserves to have
that kind of flexibility if we get into that kind of a
situation. The state's going bankrupt and our Constitution says
we must inflation proof our fund. I don't think that that's good
fiduciary responsibility for the legislature to even think about
that and so, in many respects, when I look, Mr. Storer, at how
we inflation proof now, we're inflation proofing appreciating
assets, which in many schools of thought would not be something
that most people would do. Am I again fairly close to correct on
that?
MR. STORER: Mr. Chair, to use the POMV you don't need to
inflation proof it because you are investing in inflation
proofing assets so it occurs. The problem we have is those
inflation proofing assets, such as equities, can be converted
into profits and then those profits can be distributed and so
POMV actually does memorialize inflation proofing - the
appreciation as well. The current statutes do not guarantee
inflation proofing. You still have the same debate either way,
which is inflation proof or make a payment.
CHAIR SEEKINS: In your estimation, for the coming fiscal year,
what would inflation proofing be in total dollars?
MR. STORER: I'm going to say about 575 - I don't think it's 600
million. Inflation is a bit over 2 percent right now and the
fund is such - I guess more like 500 million.
CHAIR SEEKINS: So $500 million that we'll put into inflation
proofing, regardless of what other needs the state has.
MR. STORER: Correct.
CHAIR SEEKINS: Thank you. Senator Therriault?
SENATOR THERRIAULT: Thank you. At looking at this chart I think
- something that this chart also points out that - in addition
to the inflation proofing we have - the legislature has
continued to put excess money into the permanent fund and that's
basically what the hills - the peaks are here is the retention
in the fund of excess dollars above and beyond the 25 percent
contribution every year above and beyond inflation. If you look
back over the years, of course, we've dumped in billions and
billions of dollars in just additional cash deposits too. So the
allowance over a long period of time, you know, coming close to
this line or slightly dipping below and then going back up, you
made your extra deposits, you retained the extra value here to
protect yourself against that and, you know, in addition, we
could put something on the books that would limit the draw, you
know put some dampers on the draw in any period that you did get
below.
MR. STORER: That is correct and also the legislature, if this
were the February 2000 and 25 percent of the fund was profits,
the legislature displayed the discipline that we're asking for
and did not overspend, did not exceed the 5 percent and that
gave us the cushion to work through a very severe bear market -
a 3-year bear market to where we were able to make the
distributions, we were able to inflation proof. Why? Because
that discipline was there, both in the special appropriations to
the fund and not taking more of the earnings than is necessary,
reasonable.
CHAIR SEEKINS: Senator Therriault, go ahead.
SENATOR THERRIAULT: Thank you Mr. Chairman. So with the current
situation, if you are concerned about the legislature eroding
the value of the fund, and we're getting into a tight revenue
scenario and more and more pressure to come up with money, with
that $4.5 billion sitting out there that can be realized, that
should be weighing on your mind I would think.
MR. STORER: It's available for consideration.
CHAIR SEEKINS: Mr. Storer, conceivably the legislature could
establish - to answer the question, the concern about eating
into the principal of the fund, which has been dedicated there
and I think is defined legally - am I correct there - what the
principal is?
MR. STORER: It is.
CHAIR SEEKINS: So there's a legal definition of what we consider
the principal of the fund.
MR. STORER: Um-huh.
CHAIR SEEKINS: If we were to say okay, as a legislature, we
could take that principal fund as of the end of the last fiscal
year, we could deposit into it the royalty income that we get in
from oil and natural resources. And, in addition to that, we
could theoretically take an average inflation proofing over the
last two or three or four - we do 2 years now, don't we?
MR. STORER: We take 1 year, Mr. Chair, but it's the rate of
change between the 2 years.
CHAIR SEEKINS: We could add an inflation proofing number and
establish a statutory principal number, which the legislature
could use and say you can't spend below this line and still keep
track of what the principal of the fund is after inflation
proofing and compare that to the market value to be able to see
whether or not we really are, through disbursement of the market
value, eating into the principal of the fund and use that as
legislative guidance.
MR. STORER: There's any number of pieces like that - using a 10-
year rolling average, a 5-year RIT (ph), redefining principal in
the statutes, recognizing the impact of inflation on - principal
is a notational number. It's a recordkeeping number. It has
nothing to do with how we manage the money so you can convert
that recordkeeping number by statute. My Director of Finance,
[indisc.] but that's okay, because it's one more thing to keep
track of. But that's another way of doing it and then you'd have
to change the statutes or address it through statutory change.
CHAIR SEEKINS: And by doing that we could provide some
indication of the fiscal responsibility of the legislature to
the people of the state of Alaska as we go forward.
MR. STORER: It would be a more rigorous process if that occurs.
CHAIR SEEKINS: Okay. Other questions? Hearing none, I want to
thank you very much, Mr. Storer, for coming to talk with us
today and we will move next - I think we're going to give the
full committee the opportunity to take a look and we'll address
this when everyone can be here - Senator Ellis, Senator Ogan as
well. So we'll move on from SJR 18 and set it aside and go to
[SJR] 19 and I see representatives here. We've got
Representative Croft, welcome to the committee, and representing
Senator Lincoln, if you gentlemen will put yourselves on the
record, welcome to the committee and we're eager to hear your
testimony.
[The following is a verbatim transcript.]
SJR 19-CONST. AM: PERMANENT FUND INCOME
MR. MARK STOPHA: Good morning. For the record, my name's Mark
Stopha, staff for Senator Georgiana Lincoln. She's not able to
be here today. She's attending a funeral for Chief John in
Copper Center and for approval of the committee chair,
Representative Croft will present SJR 19 and answer any
questions.
REPRESENTATIVE ERIC CROFT: And this is Representative Eric Croft
from Spenard and I'm the author of the House companion of this
measure, so Senator Lincoln asked me to be here to answer any
questions. I've learned enough from observing the Senate over
the last 8 years that sometimes the Senate wants to act and
sometimes it wants to talk and I'll do whichever the Chairman
wants this morning.
CHAIR SEEKINS: Mr. Croft, why don't you do what you think is
best for your position at the moment and we'll hear and then
we'll ask questions.
REPRESENTATIVE CROFT: Okay. The bill before you, SJR 19,
protects the permanent fund dividend. It protects the inflation
proofing of the fund and it provides that the earnings may not
be used. It's hard to talk about this in a vacuum and
particularly in light of the discussion we've just had about
percent of market value. We introduced it - the House bill over
on my side and Senator Lincoln, the Senate bill, as an effort to
reassure Alaskans that their dividend would always be there,
and, in particular that the current fiscal structure - the
current dividend structure that reflects the market performance
of the fund in the dividend, we thought then and continue to
think is appropriate. In addition, I think inflation proofing,
and possibly we just disagree Mr. Chairman, is the most
important aspect of the fund, that it provides that my children
have the same buying power of the fund, have the same choices
available to them that we have today. To inflation proof at less
than the actual rate of inflation I believe steals from my
children those very choices. I want this debate to be happening
10 years and 50 years from now on what's the proper use for the
permanent fund earnings and have them have that same debate with
the same effective real buying power. So, possibly we're at a
situation of sort of core fundamental disagreement. This would
protect a structure that has served well to provide dividends
for Alaskan citizens and protect an inflation proofing that
protects the actual real value of the fund and protects it by
inflation proofing at the real observed actual inflation rate,
not a rate we can assume.
Percent of market value, while it has certain aspects that are
in its favor, certain aspects that are positive, assumes that we
can guess what is going to happen over the next 100 years,
assumes from the last 100 years of market performance and
inflation performance, that over the average it has been 3
percent inflation over the last long extended period of time.
And over that same period of time, the market has been able to
perform at about 8 percent, that therefore we can, over the next
100 years, take the difference, take 5 percent. I don't know
that. I think if I knew what the market performance would be
over the next 100 years and knew what inflation would be over
the next 100 years, that I'd be making a lot more money than I
am today. I think there are a lot of people who, if I could say
I know absolutely what that will be, who'd be very interested in
that number. We don't know. We're talking about a period of time
that was the Dow Jones Industrial Average where it was largely
an American phenomenon in a pre-industrial and industrial
setting. I don't know what a global DOW - as the stock markets,
ours and the worlds, become more global as the economy becomes
more global and becomes more high technology, I don't know
whether those 8 percent returns are going to continue to exist -
be lower or higher. I don't want to bet the real earning power
of the fund on that experience. I don't think we know enough to
do that. I'm much more comfortable inflation proofing every year
by the actual inflation that we saw. Mr. Storer, when he was up,
talked about we hope we don't see the '70s again. I hope we
don't either but if we take - I mean if we're going to take the
percent of market value construction, that we can look back over
the last 100, 80, 50 years, and say that is going to repeat
itself, then we have to assume that things like the Great
Depression and the '70s recession are going to happen. And when
those things do happen, and you have 8 or 10 percent inflation,
you continue under percent of market value to pretend that
inflation was 3 percent. We have had those periods before. I
think we have to assume that we will again and under a percent
of market value formulation, we would be eating into the
principal.
I listened to the discussion up here. I looked at yesterday the
earnings reserve balance of the permanent fund. It's around $900
million. The great $4.5 billion you're talking about is in
unrealized gains. According to the most recent AG opinion from
Attorney General Renkes, that should be put into the principal.
I'm not sure whether that's the right legal opinion but it is
the legal opinion that the permanent fund is operating on.
CHAIR SEEKINS: I don't agree with your interpretation but we'll
put it on the record for you.
REPRESENTATIVE CROFT: Okay. Individuals, I guess, can disagree
on that. I've read that opinion a number of times. I disagree
with whether the opinion is right legally but I believe that's
what it says.
CHAIR SEEKINS: I think it's counted into principal but it
doesn't require that it be deposited into principal. I mean it's
counted in terms of the calculation, that's how I would portray
it.
REPRESENTATIVE CROFT: You might have a brilliant career forward
in the legal profession, Mr. Chairman, because that distinction
evades even me.
CHAIR SEEKINS: Well, I can understand how. Please, I'm being
facetious, just having some fun there.
REPRESENTATIVE CROFT: The fundamental aspect of the percent of
market value that disturbs me is that presupposing what we know
what inflation will be and pretending that it's that and,
frankly, the portion, and you've referred to it in some of the
testimony before, that deletes the word 'principal' from our
Constitution. We put it in there in the '70s. We're going to
take it out. I think it would be better and a sounder fiscal
policy to start by reassuring people that their dividend won't
be touched, reassuring people that real inflation proofing,
inflation proofing at the rate that actually occurred, will
happen and that's what the bill before you does. I can see that
the....
CHAIR SEEKINS: Senator Therriault has a question and if you
don't object, as we go along, we like to ask questions while
they're fresh in the minds of our members. Senator Therriault.
SENATOR THERRIAULT: I don't think you can guarantee those two
things that you just said you want to guarantee. I believe that
I tend to agree probably more - fall on the side of the spectrum
with - that you're on, as far as the importance of inflation
proofing. But we've just heard from Mr. Storer that we can have
a situation in a down equity market but continue real estate
earnings that come in that have to be paid out as a dividend
that could in fact erode the principal of the permanent fund if
we didn't have that buffer that we talked about. So you're
desiring to have absolutely guaranteed two things that under the
current situation, I don't think you can.
CHAIR SEEKINS: Please go right ahead.
REPRESENTATIVE CROFT: I listened to the entire testimony for
that reason. What Mr. Storer said was that you could reach a
situation where you couldn't pay out dividends and you couldn't
inflation proof because you'd gotten to the bottom of the
barrel. At that point, and because of market performance after
that, you could have a book value of less than principal - it
could be negative for a while. All that is true and what you do
in that situation is you stop spending. That's the appropriate
response when you've hit the bottom of your savings account and
that's not what happens in percent of market value - you keep
spending, in fact you keep spending at 5 percent assuming that
things are happening that are not happening in the real world.
CHAIR SEEKINS: You mean the bottom of your savings account or
this line below, which you should not participate. The bottom of
the savings account means it's all gone to me. How did you mean
that?
REPRESENTATIVE CROFT: The bottom of the checking account and
maybe you still have savings that you declared you're not going
to get into yet.
SENATOR THERRIAULT: It seems to me if you get down to a poor
market situation, in fact we almost got to a point where we
didn't have money to pay a dividend within the last year and
there were bills that were introduced to pay it out of the
regular state treasury because it got so close. But I think that
one of the things that Mr. Storer was alluding to is you still
would have real estate earnings coming in so you have income
that goes into the calculation of your dividend but you have no
money. The first money to go is the inflation proofing. The very
thing that you said should be paramount. I agree if the
permanent fund is the mechanism is to be a mechanism of taking a
one-time revenue stream and making it truly multi-generational,
you should put inflation proofing as your number one goal. It
should be paramount to everything else but with what you're
proposing here when you get into a bad situation, the first
thing to go is the inflation proofing.
REPRESENTATIVE CROFT: This constitutional amendment protects
inflation proofing and....
SENATOR THERRIAULT: I don't see inflation proofing in here.
REPRESENTATIVE CROFT: The statutes that we put into the
Constitution that we say - AS 37.13.140, .145, and 23.025 -
13.145 is the inflation proofing statute and then when we add
Section 2 that says that you can't amend them as they were
effective on 2002, that says dividend....
SENATOR THERRIAULT: What happens when we get into a situation
where we don't have the money under the current system to pay
them both. Which one gets paid?
REPRESENTATIVE CROFT: What you should do when you reach the end
of your principal and you get down - and principal just means a
number below which we don't want to fall, below which we want to
stop doing business as usual, and in this system you do stop. I
mean I can't protect....
CHAIR SEEKINS: In which system - the 19?
REPRESENTATIVE CROFT: The current system protected
constitutionally as SJR 19 would do. I can't guarantee you
market performance that will always allow us a dividend and
inflation proofing. Nobody can. I can, though, write a system
that says we will do that each year and when we hit the
principal number that we don't want to fall below, we've got to
stop. You have no question in my opinion, and you wait for the
markets to rebound. And then when you do, you pay those back.
You start paying dividends again and you pay back the inflation
at the real amount. Percent of market value would continue
through that entire time, pretending we could pay out 5 percent,
eroding principal and continuing to operate as though there was
something normal about that.
CHAIR SEEKINS: Percent of market value does not mandate a 5
percent payout. It limits it to 5 percent based on the fiscal
responsibility of the legislature. Senator Therriault?
SENATOR THERRIAULT: Thank you Mr. Chairman and I think language
can be, as we discussed earlier, developed that would prevent
that from happening. But you say we've got the current dividend
payout system and we've got inflation proofing. When money gets
tight, which one gets paid? Is it prorated between the two? If
you only got enough money to pay a portion, which one gets paid
- inflation proofing or a dividend under this language? Which
one takes precedent?
REPRESENTATIVE CROFT: Right. Under the current structure and
under the structure we incorporate here in SJR 19, if you get
down to that point, you keep dividends. It's a calculation that
you and I have been through.
SENATOR THERRIAULT: Right - you keep dividends. So inflation
proofing, the very thing that you said to be paramount, is now
secondary.
REPRESENTATIVE CROFT: It's secondary to dividends and superior
to everything else.
SENATOR THERRIAULT: It's secondary to dividends and, for myself,
that's a problem. Another question. In addition, Section 2 on
page 2, lines 5 through 8, you talk about an allowance for an
appropriation, above and beyond B and C sections, that I guess
would just be a majority vote of the legislature and then
ratification of the state voters and that would come out of the
earnings reserve. So you are allowing for spending here in
addition to the dividends and the inflation proofing.
REPRESENTATIVE CROFT: Well, through the chair, Senator
Therriault, we saw that as a protection. Of course they could
spend now but this would require that the people approve any
spending out of the earnings reserve.
SENATOR THERRIAULT: The people that year. So with pressure on
the budget, and the public demand for dividends, where do you
think the dollars are going to go? Is it going to go to
inflation proofing?
REPRESENTATIVE CROFT: Well, and that became the final sort of
point in the discussion here before, the idea that we, the
people or we, the legislature, would fail in our commitment on
inflation proofing. I happen to think inflation proofing is very
popular publicly and I think it should be. I hope it still is in
this legislature. I think keeping the earning power for our
future generations will win politically but the provision you're
talking about doesn't have to do with either. It has to do with
putting another protection against getting into the earnings
reserve and that government use of the earnings reserve is, in
the long run, as big a threat to inflation proofing as dividends
as the market - government getting in and taking substantial
amounts of the earnings reserve is what drives you to the very
situations you were talking about, of having no money and how do
we choose between dividend and inflation proofing. We wanted to
set one more protection to make sure that earnings reserve
stayed healthy and it wasn't used for government. If the people
say that they want to, that's their choice but we not do it
ourselves.
CHAIR SEEKINS: Go ahead, Senator Therriault.
SENATOR THERRIAULT: Mr. Chairman, this mechanism by just
enshrining the statutes, which we've also had testimony that
says we're 27 years down the track. We've changed our investment
strategy and now we're trying to freeze these statutes that
haven't kept pace with the means by which we generate revenue.
It just seems that to suggest that this is a better way, when
clearly you get into a situation where you don't have enough
money so you're going to have to pick between dividends and
inflation proofing, you could have an appropriation because of
budgetary pressure that could also take precedence over
inflation proofing, leaving nothing for inflation proofing. I
think with a segment of the state population, the inflation
proofing is very important, but we've also got a transient
section of the state population that carrying forward the
purchasing value for the next generation, they don't care a bit.
I've heard from - I have one constituent that I just had to
agree to disagree with and he said you know nobody looked out
for my generation so let the next generation look out for
themselves. I completely disagree with that and I think that
truly we should go toward something that really does guarantee
that we preserve the purchasing power. And although POMV might
not be 100 percent, it sure seems like it's a whole lot better
than what we've currently got.
CHAIR SEEKINS: And we'll go to Senator French next but
purchasing power that doesn't meet needs is useless.
REPRESENTATIVE CROFT: Doesn't meet? Sorry Mr. Chairman?
CHAIR SEEKINS: Purchasing power that doesn't meet any need is
useless. What are we trying to preserve purchasing power for
future generations if we can't feed our kids today and that's
where you and I probably basically philosophically disagree. I'd
feed my kids before I'd inflation proof my savings account. So
that's not a hard decision for me in that case. When I look at
projected shortfalls in general fund versus expenditures, you
know, we're shooting for a number around $400 million and we're
going to put $500 million first into inflation proofing. How do
people want to spend their money? Do they want to spend it to
inflation proof and then we tax them and take it away from them?
There are a lot of questions there that become very debatable
when the reality hits the pocketbook and so I'm not so sure how
people would react. I know how my wife would react if I said
baby, we're going to put the money in our savings account and
you don't have anything to go buy groceries to feed the kids and
grandkids. There'd be a revolution in the house. So, sometimes
the legislature has to live up to its fiscal responsibility
without undue restraint and I think they've got a good track
record of doing that. I haven't been here as long as you, but
the track record has been good. It's been admirable and I think
to some respect anything that we do that unduly limits the
ability for the legislature to act in a fiscally responsible
manner in the face of uncertainties, as you mentioned are surely
going to come, puts us in a position where if we don't know, why
do we want to eliminate the ability for the legislature to
respond appropriately? That's where I get into problems. Senator
French?
9:37 a.m.
SENATOR FRENCH: I think one of the remarkable things about the
current set of statutes is the degree to which the public kind
of gets how the system works. When the dividend went from $1,900
just a few years ago down to $1,000 this year, none of my
constituents were squealing about, you know, some kind of
terrible inequity in the system. They understood that it was
just a down market year and I think that's one of the
difficulties with POMV that proponents haven't quite come to
grips with that somehow POMV implies stability, that you will
have this money paid out every year irrespective of the market's
performance and yet there's sort of that little language that
says you can go up to 5 percent as if there were going to be
years when we wouldn't do that.
CHAIR SEEKINS: Well we did that in 1996, Senator French.
SENATOR FRENCH: I was almost finished.
CHAIR SEEKINS: Go ahead.
SENATOR FRENCH: So I guess the point I was trying to make was
that there's some real good value in maintaining something very
much like the current statutes because of the degree to which
the public understands that sometimes there [are] going to be
years when you just don't get a dividend because the market just
didn't provide one. So I think that's - I just think that's
worthy of making note of.
CHAIR SEEKINS: I have no problem with that but we did - in our
current system, we did, I would call it, hyper-inflate the
dividend in 1996. The decision was made by the Board of Trustees
that the current generation should, this was the rationale, the
current generation needed to get more from the permanent fund
than it was getting through the regular distribution system, the
dividend system. So, investment management companies were told
to go sell stocks to bring in realized income to be able to put
more cash into the dividend for the current generation. Now
whether that was the real reason or not is debatable, but that
was the rationale that was used. It was done. We had additional
income that came in that peaked and then went right back in
terms of realized income and so, sometimes, it isn't just market
variability that affects the dividend under the current system,
Senator French, it's also political variability. Senator
Therriault?
SENATOR THERRIAULT: Mr. Chairman, I need to disagree with
earlier comments here about people understanding the current
system and the value of that. Certainly last year when there was
the real potential that there would be no dividend, there was
enough of a concern in this building of, number one, the shock
to the citizen, the shock to the economy that there were
proposals to pay it out of the general state treasury. So I
don't think the general public has any level of understanding
that really, in the current system, that there's the chance that
there is a zero dividend year. And certainly for those of us
that know the potential impact to the state treasury, that's not
something that we would invite so I'm not going to - I guess I
can't agree with that line of thinking when there are other
alternatives that make sure that that stream of cash that goes
out into the Alaska economy is smooth and you get the by-product
of guaranteeing that inflation proofing of some degree is made
automatically independent of action of the legislature. I don't
think that the general public understands that they can get a
zero dividend year in the current system.
CHAIR SEEKINS: Right. I think that's true, too. When I was on
the Board of Trustees it didn't take me very long to figure out
that the Board of Trustees can play God with the permanent fund
and what the dividend's going to be. And in a year where the
earnings reserve was very low and you're faced with the
possibility of not having the cash to inflation proof or pay a
dividend, there will certainly be a tremendous amount of
political pressure to maybe pick some fruit that isn't quite
ripe yet in order to get the cash from realized earnings to put
into the earnings reserve account when a more disciplined
investment strategy would say it's not time to pick this fruit
yet but we need the money. So, you know, I can see how the
current system lends itself to all kinds of abuse. Senator
Therriault?
SENATOR THERRIAULT: The section, for either one of the
gentlemen, that allows for an appropriation for other than
inflation proofing and dividends - was that language
specifically left or put in here so that you could answer the
legal question of whether you've still got a public purpose?
REPRESENTATIVE CROFT: Through the Chair, Senator Therriault, no,
my purpose for putting it in, and I believe Senator Lincoln's
was to provide another check on government getting into the
earnings reserve. I think that the legal matter of whether we're
a tax free status has been at least in my mind fairly well
settled. The recent opinion by Attorney General Renkes that
constitutionally protecting the dividend didn't threaten the
tax-exempt status of the fund - in effect, if it was a public
purpose when you did it statutorily, it's a public purpose when
you do it constitutionally. And a lot of the case law that has
come down over the last five years that buttresses that
agreement or that understanding, particularly in the areas of
educational trusts, where private money comes in and the state
holds it and gives it out to go to the state university, those
sorts of cases have really taken that from what was a question
mark and a worry for a long time - nothing is certain in life
but much more of a certainty that that's not a serious question.
SENATOR THERRIAULT: Okay, well I just know from the debate over
the years, it seems like if you can still point to something
where there is a general public access, you have some protection
from the federal court because they can say well, you're not
using the money for that purpose right now but there's that
possibility so it gives you a little bit of extra protection so
I just wondered if that was part of the reason that you put that
in there because you've got this whole Section 3 here that talks
about oops, if there's an adverse tax consequence, we want this
whole thing to go away. So you must feel like there is some
possibility of that, otherwise you wouldn't have Section 3.
REPRESENTATIVE CROFT: True enough. And through the Chair,
Senator Therriault, the House version we took it out over the
last couple of months, after those opinions came down. When I
talked to Senator Lincoln about it, she said that that would be
a perfect question for the Judiciary Committee and up to you
guys to decide. I do think the case law has come down much
cleaner on the point that it is not needed. If the Judiciary
Committee felt like that was their opinion, they could take it
out. If they still wanted the protection, they could leave it
in.
SENATOR THERRIAULT: Do you yourself think that would be prudent?
I mean with the uncertainty of getting a tax ruling out of the
federal courts and then us being stuck with language in the
Constitution and we know it's a high hurdle to change it, would
it be prudent not - to go without this protection?
REPRESENTATIVE CROFT: I was convinced enough that in my version
of the bill I was comfortable pulling it out but it is a low
risk, but a risk, and I really do feel like you guys can decide.
As for me, after reading and re-reading the cases, not just the
memo that was sent to Attorney General Renkes, but the
underlying cases, I felt very confident that it was a public
purpose and would not be taxable. But, we had it in there to fit
your comfort level.
SENATOR THERRIAULT: Thank you.
CHAIR SEEKINS: Other questions? Senator French, did you have
anything? Senator Therriault? Thank you gentlemen, if you'll
stand by I do have one person who has indicated on-line that
he'd like to testify and, if you don't mind, if you can just
hang tough where you are so we can go into this. Is Mr. Gay -
Roger Gay, at the Mat-Su LIO - Mr. Gay, are you on-line? Do we
have him on-line still?
MR. ROGER GAY: Hello. Can you hear me?
CHAIR SEEKINS: Please, if you'll identify yourself for the
record? Welcome to the Judiciary Committee and please proceed
with your testimony.
MR. GAY: My name is Roger Gay. I live in Big Lake and I'd like
to say a little something about inflation proofing. In my
opinion, inflation proofing does not protect the value of the
fund. It merely subjects more money to the ravages of inflation.
Inflation is the result of the devaluation of our money. Every
year our money is worth less, and that is why the price of goods
goes up. A loaf of bread is a loaf of bread. A gallon of gas is
a gallon of gas. We can make bread and gas cheaper now than at
any point in history. Only the money has become less valuable.
Because of the Federal Reserve System and the way our money is
handled, our money has no intrinsic value. When you have a huge
permanent fund being subjected to I don't know how much of a
loss due to inflation, if you take that amount and dump it back
into the fund, that amount then becomes subject to inflation.
I'm not suggesting that we spend everything today at today's
prices, which would be the best way to get the full value of our
money. But the idea of taking money that has been hit by
inflation and fooling yourselves into thinking that you can
protect it by dumping more money into it to be ravaged by
inflation just doesn't make sense. You know we're losing a lot
of money to inflation because our money is not stable and if you
want to inflation proof, you have to work at stabilizing the
value of our money.
CHAIR SEEKINS: Senator Therriault?
SENATOR THERRIAULT: I understand your point. However, to
stabilize the value of our money is a national economic issue
that I don't know that the State of Alaska has the power to
control. But if that's a given, then that's something that's
largely outside of our individual legislative control. [END OF
TAPE.]
TAPE 04-5, SIDE A
SENATOR THERRIAULT: So should we not do that?
MR. GAY: You're not having any effect on inflation by taking
more money out of the hands of whoever, whether it's the state
or the people. You're not having any affect whatsoever on
inflation by throwing more money into the fund under the name of
inflation proofing. Inflation proofing is an oxymoron.
SENATOR THERRIAULT: Thank you.
CHAIR SEEKINS: Other questions? Seeing none, thank you Mr. Gay
for being with us this morning and providing your testimony. Is
anyone else on line that wishes to testify this morning? No one
else? Anyone in the audience that wishes to testify on this
matter this morning?
MR. GAY: I have a friend of mine that would like to make a brief
comment and his name is Gary Hanthorn.
CHAIR SEEKINS: Is Gary there?
MR. GAY: Yes he is and he has a mental disability but he'd like
to say a short word.
CHAIR SEEKINS: If he'll identify himself for the record, we'll
be pleased to take his testimony and Mr. Hanthorn, welcome to
the Judiciary Committee.
MR. HANTHORN: I'm Gary. Could you leave my permanent fund alone?
It's mine.
CHAIR SEEKINS: Thank you very much, Gary. Any questions?
MR. HANTHORN: Could you tell Mr. Kohring to give me a letter
because [indisc.] and he's supposed to get back to me for
something about my permanent fund being left alone.
CHAIR SEEKINS: Well we can't answer for Mr. Kohring here, but
you're certainly welcome to call his office. They have the
number there in the LIO and I would encourage you to do that.
MR. HANTHORN: Thank you.
CHAIR SEEKINS: Thank you for testifying this morning. With that,
hearing no one wishing to testify, we're going to close public
testimony on SJR 19. Are there any discussion points with
members of the committee? None? Seeing none, we'll hold this
over for a time when the entire committee can be here for
discussion. I want to thank you gentlemen for being with us this
morning. We appreciate your testimony and the lively discussion
and look forward to getting in this in the next - sometime soon.
With that, we have no other business before the Judiciary
Committee this morning and so we'll adjourn the Judiciary
Committee at this time [9:51 a.m.].
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