Legislature(2001 - 2002)
02/21/2002 03:33 PM Senate STA
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ALASKA STATE LEGISLATURE
SENATE STATE AFFAIRS COMMITTEE
February 21, 2002
3:33 p.m.
MEMBERS PRESENT
Senator Gene Therriault, Chair
Senator Randy Phillips, Vice Chair
Senator Ben Stevens
Senator Bettye Davis
MEMBERS ABSENT
Senator Rick Halford
COMMITTEE CALENDAR
SENATE JOINT RESOLUTION NO. 13
Proposing amendments to the Constitution of the State of Alaska
relating to inflation- proofing the permanent fund.
HEARD AND HELD
PREVIOUS COMMITTEE ACTION
SJR 13 - See State Affairs minutes dated 4/26/01.
WITNESS REGISTER
Robert Storer
Alaska Permanent Fund Corporation
P.O. Box 25500
Juneau, AK 99802-5500
POSITION STATEMENT: Testified on SJR 13
Ron Lorensen
Alaska Permanent Fund Corporation
P.O. Box 25500
Juneau, AK 99802-5500
POSITION STATEMENT: Testified on SJR 13
Jay Hogan
P.O. Box 21073
Juneau, AK 99802
POSITION STATEMENT: Testified on SJR 13
ACTION NARRATIVE
TAPE 02-10, SIDE A
CHAIRMAN GENE THERRIAULT called the Senate State Affairs
Committee meeting to order at 3:33 p.m. Present were Senators
Davis, Stevens, Phillips and Chairman Therriault.
The first order of business was SJR 13.
SJR 13-CONST. AM: PERMANENT FUND
CHAIRMAN THERRIAULT established that the Permanent Fund Trustees
had previously appeared before the committee. He wanted to use
the current meeting to review and discuss the proposal because
Senator Halford was unable to attend the meeting and requested
that final action be delayed until the next hearing.
ROBERT STORER, Alaska Permanent Fund executive director,
explained that the resolution would place a constitutional
amendment before the voters that is designed to inflation-proof
the fund by limiting the payout. He reinforced the fact that they
are recommending that the annual payout of fund income be limited
to no more than five percent of the fund's five year average
market value. They believe that, over time, they can earn a rate
of return that will exceed inflation by five percent.
The board is comfortable with the proposed constitutional
amendment as written, but they want to make clear that they
support the distinction that income from the fund, not to exceed
principal, would be available for distribution.
His next remarks referred to the following table:
Range of total 5% payout (in millions)
FY 03 FY 04 FY 05 FY 06 FY 07 FY 08
Top quartile
$1,343 $1,397 $1,439 $1,496 $1,571 $1,668
$1,313 $1,330 $1,323 $1,368 $1,420 $1,464
Median
Bottom quartile
$1,260 $1,007 $984 $1,031 $1,033 $1,020
Range of dividend distribution (in millions)
Top quartile
$930 $945 $953 $1,086 $1,270 $1,341
$853 $779 $732 $807 $929 $1,039
Median
Bottom quartile
$778 $620 $509 $551 $570 $602
Range of residual income (in millions)
Top quartile
$432 $497 $545 $519 $452 $417
$391 $418 $438 $390 $318 $272
Median
Bottom quartile
$331 $255 $265 $203 $111 $23
Money available at a 5 percent payout is shown as a median case
with a top and bottom quartile. He repeated that they expect the
beginning amount for distribution to be $1.25 billion. The chart
shows that amount is slightly increased to $1.3 billion as the
fund has stabilized at $25 billion. They have extended that
number to FY 08 and it is $1.464 billion on a median case.
For FY 03 the bottom quartile is close to the $1.25 billion
estimate at $1.26 billion while the top quartile is $1.343, which
is a fairly narrow range.
What does it mean if the statutes remain the same on the dividend
formula and the dividend payout? $853 million would be the median
case in FY 03 and $1.039 million in FY 08. In FY 03 the bottom
quartile is $778 million with a 25 percent probability or top
quartile of $930 million.
The number that has changed speaks to adjusting projections based
on short-term market volatility. The median case now is $391
million with a bottom quartile of $331 and a top quartile of $432
million. He reminded members that using a percentage formula
based on the market value has less volatility than realized
income. He then explained that the reason for the increase from
the $175-300 million projection is explained because the
volatility on the total payout is not reduced a lot from six
months or a year ago. What has changed is the realized income to
compute the dividend formula. This year there is a significantly
lower realized income number than in the four or five prior years
when there was a bull market. This means that the dividend payout
is somewhat reduced and the residual is available for
appropriation for government purposes.
He said he is more comfortable with the $175-300 million because
if the bear market ends and the market goes up, the dividend
could increase and that would leave a lower residual to fund
government.
He said he would be happy to answer questions.
CHAIRMAN THERRIAULT asked if the residual goes up because the
bear market results in losses and brings the five-year average
down.
MR. STORER said that is correct. The residual goes up because the
realized income is lower. However, the size of the fund is
smoothed out because of the percentage of market value payout.
CHAIRMAN THERRIAULT asked him to comment on the scenario in which
things had to be liquidated to achieve a five percent payout and
how that impacts the calculations for the dividend. Over time the
percentage of the five percent that goes into the dividend starts
moving up and the room for the residual starts getting squeezed.
MR. STORER said that potential exists if a substantially greater
amount was required to be liquidated. Then you would see
accelerated capital gains taking an accelerated dividend payout,
which would exacerbate the payout.
He said it is easier to manage money when you have more
information on predicted cash flow needs. They realize they must
raise substantial amounts of money in September of every year so
they build that into the structure of the portfolio so they
aren't necessarily forced into taking large capital gains or
loses. Predictability certainly helps in managing the fund.
CHAIRMAN THERRIAULT said legislators have different long-term
ideas regarding the permanent fund. A criticism of this plan is
that it has the potential to guarantee the inflation proofing,
and it spins off the revenue stream for the dividends but there
is little revenue stream left for general government without the
legislature changing the dividend program.
MR. STORER replied that as it now stands, there would be two
different formulas. One would be for the percentage of market
value approach, which limits the volatility of the amount of
money that could be appropriated in any given year. The dividend
formula is based on realized gains and not market value. The bull
market has masked the fact that realized income is more volatile
or less predictive than the percentage of market value payout. As
long as the dividend comes first, that residual amount would
absorb the volatility.
SENATOR STEVENS asked for a recap of the two formulas.
MR. STORER said the dividend formula is in the statutes and is
based on realized earnings. It is dividends, interest, net gains
or losses and the liquidation of securities. Unrealized gains or
losses are not included in the formula.
SENAOTR STEVENS asked if he was correct that the percent of
market value (POMV) is not an average, it is an annual percent of
market payout.
MR. STORER said they are proposing that it be the average market
value of the fund over the trailing five years and not to exceed
five percent.
SENATOR STEVENS asked if they couldn't eliminate volatility in
one of the two by adjusting the dividend formula to match the
five percent payout formula that is proposed.
MR. STORER said that is correct. If both were a percent of market
value you would reduce the volatility of the residual and also
the volatility of the dividend payment.
SENATOR STEVENS said the payments would be inflation proofed and
they would be real numbers.
MR. STORER agreed.
SENATOR STEVENS asked if he's correct that there is only a payout
if there are earnings over the last five years. If there were
five years with negative returns there would be no dividend
payout.
MR. STORER said that possibility, unlikely as it is, exists
whether the law is changed or not. However, the board feels it is
very important to maintain a cushion in the earnings reserve. At
the end of this fiscal year they will have a cushion of about $3
billion and if this is maintained, it is the shock absorber for a
prolonged bear market.
SENATOR STEVENS asked him to explain the cycle that would occur
with prolonged periods of high inflation and what would happen to
the payout. He also asked if the fund was inflation proofed first
or is it earnings first and the fund itself bears the risk of
inflationary times.
MR. STORER said prolonged rising inflation with financial markets
not keeping up with that growth such as in the 1970's is close to
such a scenario. In response to the second question he said that
currently the dividend formula precedes inflation. Following the
statutes, the dividend would be paid and then the inflation
proofing would occur afterwards. What they are proposing has the
effect of putting inflation proofing first.
SENATOR STEVENS asked if we would have a dividend if rates of
return were lower than inflation such as in 1976-1981.
MR. STORER said if the earnings reserve has sufficient cushion
then both goals could be achieved. He feels the current cushion
can withstand all but an extreme market.
SENATOR PHILLIPS asked if he said inflation proofing would occur
before the dividend payout.
MR. STORER said this is his opinion. He believes that by
memorializing inflation proofing in the Constitution it would
have the effect of putting inflation proofing ahead of the
dividend.
SENATOR PHILLIPS asked if it would have some affect on the payout
of the dividend.
MR. STORER said it would in an extreme scenario.
SENATOR PHILLIPS thought most people wouldn't care about the
mechanics but would want to know how it would affect their
permanent fund dividend (PFD). With that in mind, he asked if
there were polls to determine voter support.
MR. STORER said they don't feel it's appropriate for the
Permanent Fund Corporation to conduct a poll. Expanding on the
effect on the dividend, he repeated that by memorializing this in
the Constitution it would have the effect of maintaining the
purchasing power of the fund and therefore increasing the size of
the dividend over time. Without changing the formula, they
suggest it would have a long-term positive effect on the dividend
for this and subsequent generations.
CHAIRMAN THERRIAULT said he has cautioned the trustees not to
conduct polls or lobby the general public. To do so would give
them a political appearance that wouldn't ultimately be
beneficial.
SENATOR PHILLIPS asked what they would say if a legislator
offered an amendment making it a constitutional right to receive
the PFD.
MR. STORER said they have outside opinion that states if the PFD
were to be memorialized in the Constitution it would put the tax-
exempt status of the permanent fund earnings in question.
SENATOR STEVENS asked if that isn't why they have elected to be
"sort of half of an endowment." If you start taking principal
then it jeopardizes how the fund is managed, which in turn
jeopardizes the tax-exempt status.
MR. STORER said the key on the IRS ruling is that the fund can be
used for government purposes.
SENATOR THERRIAULT asked if all of the earnings had to be used
for government services. Would the IRS look favorably on a
guaranteed dividend of something less than 50 percent with the
balance allocated to government services? He supports the concept
of a guaranteed dividend and believes it might keep more Mackie
Plans from being presented.
MR. STORER asked if he was referring to a constitutional change
or statutory change.
CHAIRMAN THERRIAULT said he was referring to a constitutional
change.
MR. STORER doubted that this would be view favorably, but wanted
to defer to legal counsel.
CHAIRMAN THERRIAULT then asked about wording on page 1, line 8
that assures that principal couldn't be used for the payout.
Legislative Legal Counsel has pointed out that the proposed
wording in (b) is in conflict with that line. He wanted to make
sure it is the board's view that you would never want to get into
a situation where the five percent potentially erodes the
principal.
MR. STORER said that is correct; their counsel spoke with the
legislative counsel about interpretation. Both the board and
their counsel are willing to discuss any language changes that
might be helpful.
CHAIRMAN THERRIAULT said it's important that the language is
clear and straightforward before it is put before the public.
This would be particularly important if questions regarding the
sanctity of the principal are raised and the proposed language
leaves a gray area.
He then asked if the inflation proofing doesn't occur naturally
under the proposal since it's just retained earnings.
MR. STORER said that is correct. If the payout is limited to no
more than five percent of that moving average, it would have the
effect of inflation proofing.
SENATOR PHILLIPS asked what their reaction would be if the
question that is ultimately put before the voters asks if they
favor a constitutionally guaranteed dividend.
MR. STORER replied the potential for unintended consequences
always exists. The board hasn't addressed this explicitly but
they have been consistent in their concern about the tax-exempt
status being at risk.
CHAIRMAN THERRIAULT told Senator Phillips that needs exploring
because if the public has any suspicion that voting yes seriously
jeopardizes the tax-exempt status of the fund it will be turned
down.
SENATOR STEVENS asked if this proposal could have any long-term
impact on the rate of return the fund could earn in the future.
MR STORER said it would ensure that the fund could be managed to
its maximum rate of return without taking undo risk. If
uncertainty is created whereby substantial amounts of money from
the fund are required to fund whatever purchase in excess of that
five percent, the potential exists to manage more conservatively
to meet those higher cash flow needs. Currently they manage a
balance of meeting the annual dividend flow versus the long-term
objective. However, if they knew there was a potential for
substantial increases in the fund draws, they would have to take
less risk and manage for a less high rate of return because they
couldn't accept that interim volatility of the markets.
SENATOR STEVENS said this proposal gives more stability in
managing long-term because demands could be forecast.
MR. STORER said the more certainty any fund manager has in terms
of payout, the more effectively they are able to manage funds.
SENATOR STEVENS said it would be fair to say that if a POMV were
implemented, the Permanent Fund could grow at a faster rate.
MR. STORER said it could grow at an equal or faster rate given
the fact that uncertainty has been eliminated in the management
of the fund.
CHAIRMAN THERRIAULT asked for the current breakdown between
principal and earnings reserve.
MR. STORER said the principal is currently $21 billion and the
earnings reserve is about $3.7 billion.
CHAIRMAN THERRIAULT said with a vote of 21 and 11, the
legislature could appropriate the entire earnings reserve so they
must manage accordingly. If the proposal were adopted, they would
no longer have that ability, but the earnings reserve could be
managed more aggressively.
MR. STORER said that is correct. They are currently managing for
a five percent real rate of return because they have heard no
discussion to indicate that the fund would be used for anything
more than the dividend. As discussions accelerated to using more
of the fund they would have to incorporate that information into
the management of the fund. If it exceeded more than five
percent, then the fund would have to be managed more
conservatively.
CHAIRMAN THERRIAULT said there is the issue that the earnings
reserve is general fund dollars but it has been put back into the
fund to be managed along with the principal. However, if the
proposed language is voted on and adopted, it doesn't say what
has happened to that earnings reserve. Is it now part of the
principal of the fund or is it still available for appropriation
by the legislature? To appropriate those funds cannot be part of
the vote because the people don't have that power; only the
legislature has the power to make appropriations. There is some
problem with the wording in how it deals with that.
MR. STORER said it has always been their assumption that the
money is in the general fund unless otherwise stated by law and
the law states there is an earnings reserve. They have considered
that independent of the general fund but that it could in fact be
appropriated into the general fund. Again, it's important that
the language eliminates any ambiguities. At no time did they
consider the earnings reserve as a component of the general fund
unless the legislature appropriated it into the general fund.
It's been their intent to ensure there is a principal and
earnings reserve and that no more than five percent of the fund
earnings could be used as long as it doesn't invade principal.
CHAIRMAN THERRIAULT reminded members of the court decision on
constitutional budget reserve. Their ruling indicates they will
look at the earnings reserve as general fund dollars that is
available for appropriation with a simple majority.
He said it's important to try and understand the potential view
of the IRS because different people expect different things from
the fund. Some people want inflation proofing guaranteed, some
want a dividend guaranteed to them, and some want a potential
revenue stream available to the government. Each group will be
looking for what is important to them and will have questions
that will need to be answered.
RON LORENSON, outside counsel to the Permanent Fund Corporation,
said he is not a tax expert, but has reviewed all the tax
opinions that have been prepared for the Permanent Fund over the
years and has read a number of court decisions on tax issues in
various situations. It is his conclusion that putting the
dividend guarantee in the Constitution would place a private
interest in a government fund. This would create a bright line
and it would make the entire fund susceptible to taxation. The
risk of being wrong is so significant that it isn't worth taking
the chance.
SENATOR PHILLIPS said, "You're just one lawyer's opinion, right?"
MR. LORENSON said he's one lawyer who has spent a lot of time
reviewing these opinions, but he's not a court and not the IRS.
SENATOR PHILLIPS asked what the odds are if he were "Jimmy the
Greek."
MR. LORENSON said less than 10 percent.
SENATOR PHILLIPS said, "Okay, I like the odds."
CHAIRMAN THERRIAULT asked if he thought the higher the percentage
of the payout that is guaranteed as dividend the bigger the
problem.
RON LORENSON said certainly the greater the percentage of payout
the stronger the argument becomes that there is a significant
private interest rather than just a private interest. He hasn't
seen the question whether it is significant or not, just whether
a private interest is created. Certainly the smaller it is the
better your argument to keep from converting it to a taxable
fund, but the risk is still there.
CHAIRMAN THERRIAULT said the Constitution currently guarantees no
dividend even though that's really all that the money has been
used for.
RON LORENSON said as long as it is in the power of the
Legislature to decide what happens to the money each year it
passes the IRS test. It is in the Legislature's power now, but it
wouldn't be if it goes into the Constitution.
SENATOR STEVENS remarked the IRS would view it as an endowment
once a guarantee was made.
RON LORENSON didn't know whether they draw the distinction
between an endowment or some other kind of fund, but whether or
not it creates a private interest that is beyond the control of
the Legislature to control or appropriate.
SENATOR STEVENS asked for an explanation of the repercussions if
the IRS viewed the fund as a taxable entity.
RON LORENSON said it would be whatever the corporate tax rate is
on the realized income. It is his interpretation that all of the
income becomes susceptible to taxation once the legislature gives
up control of any portion of it.
CHAIRMAN THERRIAULT said he has examined some private interests
but the Permanent Fund is different because it can't be sold, or
willed to someone.
RON LORENSON didn't think that was ever the basis for the
question of whether it was a private interest or not. It has more
to do with the fact that the governmental entity no longer has
control.
SENATOR PHILLIPS said he's been in the Legislature for 25 years
and he's learned to ask lawyers about odds.
SIDE B
4:20 p.m.
JAY HOGAN asked committee members to read the letter dated
February 21, 2002 that was in their packets. His concern is that
the Permanent Fund was originally created as a repository for
surplus revenues. The assumption of many who voted for it was
that it would be available at such time when oil and gas
declined. That decline has come sooner than anticipated.
The euphoria of the late 1970's and early 1980's is difficult to
understand today. He referred to the $900 million appropriation
to the Permanent Fund in 1980 and the $1.8 billion appropriation
the following year. No Legislature has been able to consider that
kind of appropriation since and it is unlikely they will. The
Legislature of the 1970's took great care to draft a highly
flexible document to leave all the decisions to future
Legislatures by statute. The original amendment establishes the
fund, says the investments must be earning investments and the
income may be appropriated, as the circumstances require. Now
that the Constitutional Budget Reserve is running low, it's
important to do nothing precipitous.
Most states west of the Mississippi have small permanent funds
that come from original statehood land grants. Unlike states that
made land selections by single sections, Alaska was able to
select petroleum rich North Slope land by contiguous townships,
which gave it tremendous capabilities and opportunities. For
comparative purposes, Mr. Hogan included information on both the
Texas and the Wyoming permanent funds and that information is in
the bill file.
4:30 p.m.
SENATOR PHILLIPS said he is "the only [elected] relic left over
from the 70's" and he reminded everyone that in the 1980's the
Legislature took some of the earnings reserve account and put it
back into the principal of the Permanent Fund. "The $900 million
was symbolic because it paid for past sins of the Legislature
prior and then we doubled it again and then we have, in the 80's
specially we put in more monies to support the earnings reserve
account that was left over after inflation proofing and paying
the dividend… And one thing I want to add and you guys can
correct me from the Permanent Fund. Last year's PFD, if we did
not do that, your PFD would have been about $1,200 $1,300, two
thirds of what it is today because of the actions of the
legislature taken in the 80"s and in the 70's to do this. So lots
of cases we don't get the credit for it because we get blamed but
the public doesn't know that if we didn't take these actions,
their check would have been about two thirds the amount versus
what is today, around $1,850."
MR. HOGAN said those numbers are listed on page two of his
letter. The dedicated revenues are the 25 percent set out in the
constitution. Each source has contributed about one third to the
value of the permanent fund today.
CHAIRMAN THERRIAULT asked Mr. Storer what would happen to the
balance of the money if the Legislature didn't use the entire
payout in any one year.
MR. STORER told him that money could not be banked at the
Permanent Fund; it would have to be banked elsewhere for it to be
available at a later time. Monies allowed for payout but not
appropriated in one year would become a part of the fund value
and could not be appropriated in a subsequent year.
There were no additional questions.
CHAIRMAN THERRIAULT said the bill would be held in committee
while they worked to resolve some of the issues that were raised.
There being no further business to come before the committee,
Chairman Therriault adjourned the meeting at 4:47 p.m.
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