SB 21-PERMANENT FUND: INCOME; POMV; DIVIDENDS  3:31:34 PM CHAIR DUNLEAVY announced the consideration of SB 21. 3:31:57 PM SENATOR BERT STEDMAN, Alaska State Legislature, Juneau, Alaska, sponsor of SB 21, stated that the bill is before the committee for the second time and provided an overview as follows: In essence what this bill does, rather than address a packet solution for the budget deficit is to take a look at the permanent fund or big-earning engine of roughly $55 billion and take a look at that as far as how much it could produce in payouts that would include dividends or other sources of expenditures, and what percent we can pull out of that and how could we manage that asset to protect if for future generations of Alaskans. We were fortunate enough to be here when we had the massive wealth oil-bubble run through the state; unlike some of our grandfathers or grandparents who missed it just due to the age cycle or future generations of Alaskans that aren't even born yet, that they can see, especially the future generations, can see that we secured a vast amount of the wealth bubble for their benefit also, that we don't use it over the next dozen year or less on ourselves. 3:33:43 PM SENATOR STEDMAN specified what SB 21 does as follows: This bill what it does it would limit the withdrawal annually to 4.5 percent of the market value and there's an averaging over the last five years that takes place, so you don't take just the last year's ending balance, but you back up six years and take the first five of that, so it makes it very predictable for the budgetary folks to know exactly what revenue they would have. A 4.5 percent withdrawal on average over time the market should and returns should suffice and there will be other presenters with better backgrounds that can address that to the committee to ensure that we don't diminish the purchasing power and or spend down the fund. Of that 4.5 percent, 2.25 percent would be, or one half of it would go to dividends automatically, to the citizens, and that would grow over time. The other 2.25 percent of the 4.5 percent, the other 2.25 percent or one half, could be added to the dividends if we are so fortunate as to have robust economies and an easy time balancing the budget, it could also go back to the permanent fund, or could be used, which would happen over the next several years go to the general fund of the state to help us when we have financial difficulties like we have today. So that would ensure that the public gets 50 percent of it in a dividend, the other 50 percent every year would come before the Legislature and the elected body would decide to add it to the dividends, send it back to the permanent fund, or take it to core services like education or health and human services or what have you. 3:35:53 PM SENATOR STEDMAN summarized as follows: In a nutshell, that's what this bill does; again, it's not a one-bill solution to our deficit issue, but it's a protective mechanism to ensure that we have a very valuable asset for future generations to be able to rely on also, that we don't basically, we the Legislature, including myself, all 60 of us, all good intended elected officials, collectively we can be dangerous, don't start taking chunks out, the billions, and hurt the last 40 years of wealth accumulation. CHAIR DUNLEAVY remarked that during the past several years there have been people trying to sell that using the permanent fund would be immune from market fluctuations versus the volatile oil markets. He asked Senator Stedman to confirm that the permanent fund is not immune from fluctuations. 3:38:20 PM SENATOR STEDMAN answered correct. He pointed out that SB 21 uses five years of market values to smooth out volatility. He noted that he worked with the City of Sitka 30 years ago in changing their all-bond portfolio to a percentage of market value that took a five-year average. He noted that unlike SB 21 with a 4.5- percent payout, Sitka chose a 6-percent payout. He admitted that Sitka's 6-percent payout has shown to be too high and their fund's purchasing power has decreased. He emphasized that the financial markets are not linear and noted that the economy has experienced 3-economic shocks over the past 30 years; however, a withdrawal based on averages from 4 to 6 years smooths out fluctuations and makes things more predictable. 3:42:22 PM CHAIR DUNLEAVY asked Senator Stedman to dispel the notion that withdrawing funds from the permanent fund will take care of the state's fiscal issue. SENATOR STEDMAN concurred with Chair Dunleavy. He noted that SB 21 is a bill for statutory change rather than constitutional change. He admitted that the Legislature could still get around the bill's 4.5 percent withdrawal by spending the earnings reserve which is not protected by the constitution. He disclosed that approximately $14 billion is available for the Legislature, "To get its hands on." He pointed out that if SB 21 was adopted in the constitution as an amendment, the Legislature would never be able to take more than the 4.5 percent in any given year without the permission of the citizens. He addressed scenarios on the Legislature sharing the 4.5 percent withdrawal with Alaskans as follows: That 4.5 percent, if we gave them no dividend out of it and took it all to the general fund we could probably make it work and get out of this hole; I think that's politically not attainable and I personally would not support it. I think if we have a sharing relationship with the dividends, with the people, with the state, there's a balance clearly. If we take it all to the general fund, the whole 4.5 percent, we are going to pretty much fix our problem, make it pretty easy to get out of; but, if we take none of it and it all goes to the dividends, we can't get out of this hole, I don't see any mathematical way we can do it. So somewhere there's a balance and that in lies the 50 percent split and I think hopefully gets the public's support behind it. CHAIR DUNLEAVY reiterated that the permanent fund will not be a constant flat stream and will not take care of the state's fiscal problems. He pointed out that the state's fiscal problem is so great that $1.2 billion to $1.5 billion draws would be nowhere near the $2.8 to $3 billion deficit. 3:45:27 PM SENATOR STEDMAN answered correct. He set forth that a withdrawal from the permanent fund would act as a base, but other solutions such as budget reductions and revenue enhancements will be required to fix the budget deficit. He said the state's hole is structural and the quicker the Legislature can dissolve the structural deficit and get back to balanced budgets the better off all of us are. SENATOR WILSON noted that Senator Stedman's presentation showed the permanent fund's balance growing. He asked Senator Stedman to explain how he came up with the numbers that showed the fund growing. SENATOR STEDMAN explained as follows: If the average rate of return is higher than 4.5 percent, it will get larger; if it's higher than 4.5 percent plus the rate of inflation, say the rate of inflation is 2 percent, just as a number, and you made over 6.5 percent, your real purchasing power will start to increase. There will be times I can assure you that the purchasing power will decline in the short run just due to market reductions. 3:48:11 PM SENATOR WILSON asked to confirm that the additional earnings would go into the earnings reserve account. SENATOR STEDMAN specified that the bill does not eliminate the earnings reserve and detailed as follows: The earnings reserve are trading profits and potentially the unrealized gains. The corpus is what's protected by the constitution, roughly $40 billion. So we can, we the Legislature, if we adopt this in statute, we still can get around the 4.5 percent and spend the earnings reserve; it would take a constitutional change to block that and limit us just to 4.5 percent and that discussion would come later. I personally support that, but it has to take the will of the people. So you could adopt this statute, pay out 4.5 percent and then have an election of spendthrifts and they decide to come in and say, "We don't like 4.5 percent, we want $4 billion or $5 billion because we want to do this project or we want to build roads or more ferries," or whatever they are going to build and go in and take it out of the earnings reserve. There still needs to be some prudence on sticking with the 4.5 percent to make sure that that does not happen. If and when we take it to a constitutional amendment, the earnings reserve then would eliminated, it would have no, from what I can see, no value. SENATOR STEDMAN disclosed that SB 21 does not change the Alaska Permanent Fund Corporation's structure and detailed as follows: We are not turning the permanent fund on its head and changing its time horizon or its liquidity needs and things of that nature; it pretty much keeps the status quo and it puts them out, kind of silos them off on the side where we clearly would have in front of us a deficit issue. We can't just look over to the permanent fund and grab billions out and not make the hard decisions because we have some tough ones as we all know to make and they are not going to be fun. 3:50:55 PM CHAIR DUNLEAVY asked if SB 21 sets an amount for inflation proofing, not passive inflation proofing. SENATOR STEDMAN answered that SB 21 does not and detailed as follows: What sets the trigger or the mechanism to allow it to inflation proof itself is the payout rate, and the asset allocation and performance of the fund itself. So given roughly the current allocation and historic performance of all of those asset classes helps derive the payout rate and there's no magic number. I thought 4.5 percent just from my past professional experience is reasonable and attainable, some folks might think it should be 4.75 percent or 5.0 percent and the next guy might think it should be 4.25 percent; I think that should be left up to the discussion and recommendations from the permanent fund and maybe the Department of Revenue and debated in the finance committees or whatever, I just picked that number from professional experience of what I thought would work. He addressed a scenario where the fund's rate of return was 5 percent over 10 years with a 4.5-percent withdrawal as follows: We would be going backwards with purchasing power if inflation is 2.0 percent, 2.5 percent, historically it has been 2.5 percent the last century; but you have to have an asset allocation mix that is in balance with your payout. So if you ratchet the payout up, sometimes you could push your performance requirements of your portfolio managers to a point where your risk level gets a little bit too high, in my opinion, and that works with this or a retirement fund or your own personal stuff also. 3:53:01 PM CHAIR DUNLEAVY asked if SB 21 would automatically pay a permanent fund dividend (PFD) or if paying a dividend would be optional for the Legislature to appropriate. SENATOR STEDMAN replied that the dividend would be 2.25 percent of the market value. He noted that there has been a discussion and debate as to whether the PFD is an appropriation, but the bill does not address that. He emphasized that the dividend payout would be a minimum of 2.25 percent. He said there is almost a compact agreement with citizens on the split. CHAIR DUNLEAVY asked Senator Stedman to address Section 3, line 13, which says, "The Legislature may appropriate." He asked what would happen if the word "may" was changed to "shall." SENATOR STEDMAN replied that Chair Dunleavy's question would be a good question for the attorneys. He said he understood the difference between "may" and "shall," and would be comfortable with either one of the words. CHAIR DUNLEAVY replied that the words are very different. SENATOR STEDMAN responded that he knows the words are very different and detailed as follows: If I can put on my "elected official hat," it's 2.25 percent. I personally would not care speaking to my constituents if it said "may" or "shall," it would be 2.25 percent and the check should be written and we should deal with our fiscal issues however we need to deal with them. 3:55:01 PM CHAIR DUNLEAVY remarked that you would never hear from Alaskans when the dividend was calculated by market outcomes, but they have become suspicious and untrusting when the dividend was vetoed last year. He said the suspicion by Alaskans is the reason why he brought up the concepts of "mays" and "shalls." He pointed out that legislation and appropriations could still be vetoed, but constitutionalization gives Alaskans a little more feeling that they and future generations are being treated as partners. 3:57:55 PM CHAIR DUNLEAVY thanked Senator Stedman and held SB 21 in committee.