SENATE BILL NO. 84 "An Act making a special appropriation to the principal of the permanent fund; and providing for an effective date." Co-Chair Halford took up SB 84, an appropriation from the permanent fund reserve to the permanent fund principal. In the introduced form, it appropriates the entire reserve to the principal. There are two areas which have raised significant questions. What is the effect of the appropriation of the entire reserve to the principal on either dividends or inflation-proofing? What is the effect of appropriating the reserve to the principal on any other calculation on revenue available for appropriation as it applies to the constitutional reserve account. He noted for the record, "it is not his intention to make it easy to spend funds from other accounts. Co-chair Halford recognized the two different CS Work Drafts indicating the differences between the two. He noted that one provides, that at any time the amount in the reserve account exceeds $250 million, after dividends and inflation- proofing, it goes to the principal. The other CS appropriates all but $250 million to the principal. Senator Phillips stated his concern regarding this appropriation affecting the constitutional budget reserve account. Co-chair Halford asked, "If you reduce the amount available for appropriation by taking the permanent fund reserve off the table, do you then trigger the simple majority vote to the constitutional budget reserve?" Senator Rieger expressed his reservations concerning the bill. He supports making it more difficult to spend the money. He noted with the fiscal gap, people are cautiously looking at the spending. Some factions advocate no new taxes, some factions do not want the dividend to be touched. Today, it is possible to confirm that the budget will not be cut, the taxes will not be raised, and the dividends will be left alone. This would be possible for five years with the present reserves. This measure makes it less possible after that time. The reserves would be exhausted, in that context he supports it. Senator Rieger is convinced there needs to be measures taken to protect the permanent fund. He stated that he is also reserved with a bill he has co-sponsored. There is an effort to build up the fund which puts another billion dollars into it if it were to pass. He indicated an insecurity of the institutional protection of the fund in inflation-proofing and management. The two previous administrations have removed and selected new trustees. The elected governor controls a $3 million budget which is dwarfed in comparison to gaining control of a $16 billion fund. He expressed strengthening the protection institutionally, given the power vested in an individual to control these funds. He stressed that as the fund is built up, there is a need to protect it for future generations. Co-chair Halford asked Mike Greany to give an update on the "sweep" mechanism. Mr. Greany addressed the possible effect on SB 84 on the constitutional budget reserve. He spoke from a chart entitled, "Preliminary estimate of funds available for appropriation for FY96 for illustrative purposes". He provided information based on a rough calculation on funds available. He noted that what is needed is a process that identifies all the accounts that the court would consider available for appropriation and those accounts that are subject for sweep for repayment for the fund. Co-chair Frank spoke to the rough calculation. He asked, if a remainder of $452.2 million was left in the permanent fund reserve would that negate the provision? There are a number of subsidiary accounts that have not been included that could swing the number in either direction. He then asked, "is there a direct dollar-for-dollar relationship for the amount left in the permanent fund reserve, unprotected by being in the principal, to the amount that can be appropriated from the constitutional reserve by a simple majority? Mr. Greany responded that the earnings reserve of the permanent fund is the largest single fund available to appropriate. Co-chair Frank asked that if the calculations are correct and the funds were appropriated, except $452.2 million to the principal of the permanent fund, would there be any affect at all on the availability of the constitutional budget reserve? Mr. Greany answered that the legislature would not be able to use the simple majority to access the funds, it would return to Article IX, Section 17C, which requires a three-fourths vote. Co-chair Frank noted that if $500.0 million were left in the fund to give a margin of error, then it would be clear you would not be able to use the simple majority feature under Section 17B. If the funds were going to be utilized you would have to use Section 17C. Mr. Greany pointed out the other variable is the amount of money available from AHFC or AIDEA. The funds from those corporations is available to the extent that they have actually been appropriated as opposed to what may be theoretically available to appropriate. Discussion was had regarding Article IX, Section 17 B,C, and D. Jim Kelly of the Alaska Permanent Fund in Anchorage joined the committee via teleconference. Co-chair Halford reiterated the previous discussion. He noted that two CS's are before the committee. One provides that at any time the amount in the reserve account exceeds $250 million, after dividends and inflation-proofing, it goes to the principal. The other CS appropriates all but $250 million to the principal. There are questions to the effect of the appropriation of the reserve on dividends or inflation- proofing. Mr. Kelly responded that the problems that arise are due to the description of income available for distribution. Income available for distribution is 21% of the last five years income, but may not exceed that income of the current year plus the balance. Mr. Kelly indicated that this year, there is no problem with an appropriation of the total amount. The reading of the bill would allow for the dividend calculation to take place before the transfer. The problem would arise next year potentially, if the amount of money earned is less than the five year average. If the funds earned 6.49% next year, there would be an earnings of $993 million. The amount would be less than the five year average. That would be the amount that would be available for distribution. The appropriation for the dividend would then take half of that, which would have a negative impact on the dividend of approximately $60 million. The proposed CS's that would leave $250 million in the account would alleviate that problem. The permanent fund has added to the earnings reserve account 13 years out of 15. The two years it was taken out, amounted to a total of $30 million and $24 million, respectively. Co-chair Halford stated that in the past, the money out of the reserve, went to inflation-proofing not dividends. There is a dependance upon income, inflation rate, and average, which determines whether the short-fall occurs on the dividend-side or inflation-proofing-side. Mr. Kelly projects an 8.11% rate of return for next year. If inflation is 3.75%, there would be an additional $100 million added to the earnings reserve account next year. Co-chair Halford spoke to the committee substitute's. He prepared a CS which provides that anytime the balance in the reserve account exceeded $250 million, it would be automatically transferred to the principal. With regard to the impact of inflation-proofing, he said, and with $250 million in the earnings reserve account there would have been no problem in the last 15 years at all. Co-chair Halford then addressed the problem of the appropriation of funds exceeding $250 million which becomes a dedication and a substantive law opposed to an appropriations bill. He asked Mr. Kelly to give the history of the appropriation versus non-appropriation of inflation-proofing and dividends with regard to the permanent fund? Mr. Kelly responded that in the early years, dividends and inflation-proofing were not appropriated. It wasn't until the Cowper administration that sections of the bill provided for appropriated dividends and inflation-proofing. Co-chair Halford asked if it is based on the last phrase of the permanent fund language in the constitution, "or as provided by law"? Mr. Kelly responded that it was substantive law, and was interpreted to count as the appropriations for all those years. Co-chair Halford asked if it was ever successfully challenged? Mr. Kelly said there was never any legal action, just a change of policy. The legislature began including those sections in the front part of the bill. Senator Sharp asked if the 6.49% was a line of demarkation in ending up without enough funds for inflation-proofing? Mr. Kelly's projection using 6.49% would be a problem. He stated that if the earnings were less than $1,130 billion, there would be a problem. Senator Zharoff asked, what is the balance in the permanent fund to date? Mr. Kelly stated that the principle at the end of the year will be $13,500,000,000; in the earnings reserve account, $1,116,000,000, both at cost. There is an additional $750 million in unrealized gains. Total is $15 billion. Senator Zharoff referred to the CS that made mention of, "June 30th of each year after the transfers under B and C of the Section, the amount that exceeds $250 million shall be transferred." He questioned if the CS would bind the appropriation power of future legislators? End: SFC-95, #6, Side 2 Begin: SFC-95, #8, Side 1 Mr. Baldwin, Assistant Attorney General, and Mr. Slotnick, Assistant Attorney General were invited to join the committee to review past and present interpretation of the law. Mr. Baldwin stated that in a recent decision of the supreme court interpreting the amendment, there was discussion of the automatic transfer mechanism that is in statute. The opinion written during the Hammond administration expressed the opinion, that the inflation- proofing transfer could be automatic, based upon a fulfillment of a fiduciary obligation by the state to keep the fund above the inflation level. He stated that it is not set out in statute. Since it was established as a trust, the reasoning dictated a fiduciary obligation as trustees to treat it as a trust. He noted that a later administration decided that the constitution was not clear on how the provision was to be implemented. Whether the last sentence of the amendment does authorize the automatic transfer, or whether it implies that the legislature should appropriate it. From the Cowper administration to the present, the money has been appropriated along with the dividend. With regard to the law, the implementation is not clear. One could argue that the constitution does not take away the legislative power to appropriate funds, that it merely authorizes the legislature to act consistent with other powers granted in the constitution. Senator Rieger asked if there is a difference between the responsibility of a fiduciary and a trustee in the context of overseeing a fund? Mr. Baldwin stated a trustee has fiduciary obligations, to make prudent investment and management decisions. Senator Rieger stated that much of the debate concerning the constitutional provision on providing for the disposition of earnings requires a definition of earnings. In the past the handling of the return of capital, which represents the inflation rate, was treated as if it were earnings. Mr. Baldwin addressed the question of what is in the general fund versus what is not in the general fund. He stated that there is a difference of opinion between legislative lawyers and executive branch lawyers. Mr. Slotnick responded to the question of funds, other than the earnings reserve, which would be available for appropriation for purposes of Section 17B, but not for purposes of 17D. He cited Science and Technology Funds as an example. These particular funds are outside the general fund and would be available for appropriation for purposes of 17B, but not for 17D. There may also be other funds within some of the public corporations which would be available for appropriation. He said they cannot be spent without further legislative action, but would not be available for appropriation for purposes of payback because they are lodged in public corporations. Co-chair Frank asked how this was different from what Mr. Greany said? Mr. Slotnick stated that Mr. Greany identified only the earnings reserve as a certainty outside the general fund and not available for sweep. He is correct that it is the only fund the supreme court identified in the Cowper case. Co-chair Frank said that at issue are the equity balances of the large public corporations. Mr. Slotnick stated that at issue are certain funds within those public corporations which cannot be spent without further legislative action. Actual equity balances of AHFC are not on the table as available for appropriation unless in fact they are appropriated. There may be funds that cannot be used for revolving loans, or that the University cannot spend without an appropriation. These would be considered available for purposes of the calculation, but not necessarily for purposes of payback. Senator Rieger asked if this was made clear in the judge's ruling or is this an interpretation of what was said? Mr. Slotnick stated that the supreme court was very clear in footnote 32 which recognizes the distinction between 17B and 17D. The court stated that "the earnings reserve fund is outside the general fund." He went on to say that, "if no further legislative action is required, then it would not be considered available for appropriation unless it is actually appropriated". Senator Rieger questioned the feasibility of taking all assets in the general fund and moving it over for management by the permanent fund. Mr. Slotnick responded that it was debateable. Not everyone agrees with his legal interpretation of whether the assets in the permanent fund are in total outside the general fund. Mr. Slotnick said that the legislature does have that authority. Mr. Baldwin stated that it is the Legal Department's opinion that the legislature has the power to create certain funds that are outside the general fund. Senator Rieger asked, "without a constitutional amendment?" Mr. Baldwin noted that the legislature has done that by creating public corporations. Mr. Slotnick commented that the administration is opposed to SB 84. It makes access to the budget reserve easier which could lead to smaller dividends upsetting the inflation- proofing process. Another valid concern is the State's bond rate. It could cause it to undergo scrutiny, possibly leading to a down-grading. It also takes away the insurance policy, it takes away options, and it undercuts the work of the long-range fiscal commission. No one has identified to the administration's satisfaction the need for this bill. Transferring the earnings reserve will not increase the dividends, because the earnings from the earnings reserve are already accounted for in the formula that calculates the dividends. The bill is not necessary to protect the earnings reserve account from sweep. It is not eligible for sweep, back into the constitutional budget reserve, and it is not necessarily to protect the earnings reserve from spending as there is no spending proposal. Co-chair Halford stated that the committee has dealt with the question of permanent fund dividends and under existing projections it would have done nothing. He said that there is an interest to deal with any impact on the constitutional budget reserve availability. Mr. Slotnick stated he was speaking to SB 84, not the committee substitutes. His largest concern is, access to the budget reserve. It's not clear that the CS's have solved that problem because the formula compares the amount appropriated in one year with the amount available for appropriation. If there is a smaller balance in the earnings reserve, then access to the budget reserve under a simple majority is more likely. Senator Phillips stated that this fund of over $1 billion, is subject to legislative appropriation. He stressed there is a mistrust of this legislature to spend the money correctly, which is why it is wanted in the permanent fund. Mr. Slotnick's response to that statement is, "if they don't spend it, it stays in the earnings reserve where in fact it is serving a purpose. The purposes are to keep our financial picture healthy. Senator Phillips interjected that it is always subject to legislative appropriation, and the fear is the legislature can appropriate that money for any purpose. The legislature has that authority. He felt that it is good public policy to have that distrust of the legislature. He feels it should be in the permanent fund so that it cannot be spent. Senator Phillips wanted the public policy statement announced for his constituents. Co-chair Halford asked if there was anyone in the room who believed that if the other $1.2 billion had not been deposited to the principal of the permanent fund, that it would not have gone into the budget gap of the mid-eighties? There was no response. Mr. Baldwin stated that he wasn't sure which CS the committee was considering or how the committee was proposing solving the problem with the constitutional budget reserve for FY95. He felt that if the amount of $250 million was left in the account, it might help solve the problem this year. Assuming that you appropriate $700 million from the earnings reserve account into the permanent fund, we have a big problem next year. This would occur because the appropriation level for FY96 just jumped up $700 million. The amount available for appropriation is going to be lower next year. This means, in an election year, access in CBR is very easy by the majority vote. Co-chair Halford said that the solution is to combine the CBR and the permanent fund principal with earnings reserve account. Mr. Baldwin pointed out that Mr. Greany's illustration addresses the problem for one year only, it doesn't show what happens the next year based on a large appropriation this year, which means the appropriation level is much higher than the amount that is available for appropriation in the succeeding year. Senator Sharp stated that it was difficult to accept the transfer of funds being called an appropriation. Mr. Baldwin said that if you are sending it from the earnings reserve to the principal that would be an appropriation. Senator Sharp indicated that the debate during the election was the appropriations of funds available to meet the needs of the operation of the governor, not transferring funds instead of retaining. Mr. Baldwin stated the court did try to argue a portion of this issue in a supreme court case, but the supreme court has come down and spoken on this question. It is the decision that governs. Co-chair Halford stated, that if there were no more questions on this bill, it would be taken up at the next meeting. and the two