SB 26-PERMANENT FUND: DEPOSITS; DIVIDEND; EARNINGS  3:59:06 PM CHAIR DUNLEAVY called the committee back to order and announced the consideration of SB 26. 3:59:27 PM RANDALL HOFFBECK, Commissioner, Alaska Department of Revenue, Juneau, Alaska, addressed the comparison between SB 26, the Permanent Fund Protection Act (PFPA), and SB 21 as follows: · Rule-based: ƒPFPA: yes; ƒSB 21: yes. · Stabilizing-investment income: ƒPFPA: partial, 5-year averaging in percentage of market value (POMV); ƒSB 21: Partial, 5-year averaging in POMV. · Stabilizing-total revenue: ƒPFPA: partial, addressed in a mid-range of oil prices; ƒSB 21: no defined plan. · Sustainable-protect the dividend: ƒPFPA: yes; ƒSB 21: yes. · Sustainable-protect the fund's total and corpus: ƒPFPA: yes, maintains value of the fund and corpus over the long term; ƒSB 21: partial, the total fund value is maintained but the growth is not protected in the corpus. · Maximize the earnings reserve account (ERA) use: ƒPFPA: yes, withdrawing less when oil revenues are high allows higher draws when oil revenues are low; ƒSB 21: partial, withdraws same percent each year regardless of budget need. COMMISSIONER HOFFBECK said the state is facing a fiscal crisis that requires steps to be taken that are not comfortable but are necessary in order to actually resolve the fiscal situation that the state is in. He emphasized that the permanent fund is the state's largest tool for solving the fiscal crisis and its use maximized. He disclosed that the Department of Revenue did the modeling on what the largest-sustainable draw would be for the permanent fund that would: · Not put the fund's corpus in jeopardy; · Allow the fund to grow with inflation over time; · Allow the fund to maintain its real purchasing power; · Allow as much money as possible to be used for paying both the dividend and for providing money for funding government services. He set forth that the Department of Revenue determined that a 5.25 percent draw was aggressive with probabilistic modeling that takes into account anomalies and down markets showed the percentage still survived. He added that McKinsey and Company reviewed the department's modeling and concurred that 5.25 percent was a realistic goal. He disclosed that McKinsey and Company is internationally known on Wall Street and with sovereign wealth funds all over the world. 4:02:00 PM At ease. 4:02:45 PM CHAIR DUNLEAVY called the committee back to order. COMMISSIONER HOFFBECK explained that important components were needed to be met when putting together the bill's structure. He set forth that using the permanent fund's earnings must be rules based to avoid overdrawing the fund as well as a draw that could stabilize revenues for the state of Alaska. He noted that the bill introduced in the previous session originally had a fixed draw, but was rejected as being too constrained, so a POMV approach was adopted which the Senate approved last year. He added that other important components include protecting the dividend and the fund's corpus, and maximizing the use of the fund to generate as much revenue as possible for solving the fiscal problem. CHAIR DUNLEAVY asked Commissioner Hoffbeck to clarify that when he said "stabilize revenues" he meant stabilizing the revenue stream coming out of the fund, not stabilizing the entire revenue stream. 4:04:31 PM COMMISSIONER HOFFBECK replied that the PFPA does more by tying to oil-price revenues that acts as a shutoff valve as oil prices recover and the state gets more revenue from oil rather than the permanent fund. He said PFPA stabilizes the state's major revenue streams. He admitted that annual fluctuations will occur, but five-year averaging will take a lot of the fluctuations out of the equation. He concurred with Chair Dunleavy and Senator Stedman that SB 21 and SB 26 do not get the state to the finish line by itself. CHAIR DUNLEAVY asked what Commissioner Hoffbeck meant by saying, "Stabilizing the permanent fund." 4:06:27 PM COMMISSIONER HOFFBECK clarified that he said, "Protecting the dividend." He explained that the dividend has become a very important part of Alaska's economic base and the administration felt it needed to be protected, but not at the rate over $2000 a year because it took too much and left the state too far away at closing the gap. He continued as follows: Essentially the size of the dividend at $60 oil equates to the size of the deficit and it's not that the dividend creates a deficit, it gives us kind of a way to think in our mind just how big the deficit is with various sizes of dividends. So if you pay a $2000 dividend, you have about a $1.3 billion deficit using the 5.25 percent draw. If you pay a $1000 dividend, you've got about a $700 million deficit and the difficulty in closing $700 million is tremendous, but to close $1.3 billion becomes almost insurmountable; essentially that would require the entire $750 million in cuts that the Senate has discussed and a full broad-based tax to close that in order to pay the $2000 dividend. 4:08:03 PM CHAIR DUNLEAVY pointed out that the decades-old calculation for the dividend was determined without interference from government whereas the dividend in the PFPA is determined by the government based upon the deficit or how much the state needs. COMMISSIONER HOFFBECK confirmed that the entire 5.25 percent draw from the permanent fund goes into the general fund. He explained the formula for the dividend as follows: Twenty percent of the draw, the 5.25 percent draw, goes to pay the dividend as well as 20 percent of the non-constitutionally deposited mineral royalties, those two together create the dividend; so it's still formula driven, but it goes directly through the general fund and comes out of the general fund. If that becomes a sticking point to getting this to the finish line, we have no problem of just dumping it into a dividend fund similar to how it is done now. We just felt that it was cleaner to run it through the general fund since it's flowing through there anyway, but that is not a critical piece to the plan. 4:10:01 PM SENATOR WILSON pointed out that Commissioner Hoffbeck keeps saying, "Protecting the dividend." He asked what the purpose is of protecting the dividend. COMMISSIONER HOFFBECK replied that that the PFPA protects the earning reserve from being drawn to the point where the state won't be able to pay the dividend. He specified that the idea is to protect the entirety of the permanent fund including the portion that goes to pay the dividend. SENATOR WILSON said he constantly hears from a lot of bills similar to SB 21 and SB 26 that the permanent fund has to be protected. He asked if the protection was needed because government does not have the discipline to find another solution other than to go the route of SB 26. 4:11:47 PM COMMISSIONER HOFFBECK concurred with Senator Stedman when he talked about "wolves." He commented as follows: It's just kind of the reality of what we face when we bump up against these decisions. If you are sitting there with a $500 million hole that you need to fill in the budget and that means either you put in a broad-based tax and that fills the committee rooms with angry people, or you put in $500 million worth of expenditure cuts and that fills the rooms with angry people, or $500 million you can just take it out of your savings. There's a lot of incentive to just go take it out of your savings and that's why we think that structure needs to be there so that if you go to take it out of your savings, you have to answer to the public why you didn't follow the rules that you set up, it's exactly what the administration is facing right now because of the governor's veto. We believe that the governor had all of the rights and authority to make the veto or he wouldn't have done it; that being said, the people stood up and said why didn't you follow the rules, you've been following that same rule for 30-plus years, why didn't you follow it this time. I think by putting a structure around any restructuring of how we use the dividend and a real framework, we put ourselves in the position that any time that we don't follow the rule, we have to answer to the public why didn't we follow it. 4:13:27 PM SENATOR WILSON asked why the government should get more than 50 percent than the people get in terms of the payout from the dividend. COMMISSIONER HOFFBECK opined that a 50-50 split is easy to explain. He asserted that there is nothing structurally significant about a 50-50 split. He explained that the current dividend formula was the product of political compromise and there was nothing magical with the calculation. He emphasized that a 50-50 split does not get the government to the finish line. He remarked that the administration did not say, "Let's go grab some money from the citizens of the state of Alaska." He asserted that the PFPA squeezes as much out for the dividend while still having a reasonable expectation to be able to close the rest of the fiscal gap. 4:15:16 PM CHAIR DUNLEAVY referenced an earlier discussion with Senator Stedman on constitutionalizing SB 21. He admitted that no matter how much the legislation is ring-fenced in statute, the governor is able to veto or one could change the statute in one session. COMMISSIONER HOFFBECK replied that Chair Dunleavy's point is well taken and agreed that not only could the administration veto it, but the Legislature could just choose not to appropriate a dividend in any given year as well under the formula. He said the assumption is people are going to follow the rules. He addressed the concern with constitutionalizing the legislation as follows: The concern with putting in the "constitutional" is exactly what the founders, the ones who wrote the constitution about this whole idea of "siloing" revenues for set expenditures, they prohibited the dedicated funds within the statutory language specifically in the constitution because they saw the issues that are associated with putting your money in silos that can't be broken and when you put them in silos that can't be broken, now you end up in situations where often times you could have money sitting here that you didn't need that you need to spend over here, but you would have no access to it. So that's the real danger you have by putting it in the constitution is that you would tie it up to say this is exactly where it's going to have to go, you could be in a situation where you couldn't pay your general obligation debt or you couldn't make payroll or some other thing and you would not have access to those funds. So it really ties, not so much the administration's hands, it's the Legislature's hands, you're taking away your own appropriation authority by putting it into the constitution. The administration can't spend what you don't appropriate, so it really is an issue of some of your flexibility, your appropriation authority that would be tied up by moving it into the constitution; but, just as a general statement, it's not good public policy to silo your revenues and lock them up where they can only be spent in a certain fashion and not have the flexibility to move the money around if you need to. 4:18:00 PM CHAIR DUNLEAVY pointed out that the state had a rules-based system for decades that changed because it was statutory. He reiterated that the PFPA does not provide protection, it just changes the way the permanent fund is dealt with. COMMISSIONER HOFFBECK clarified that the PFPA changes the formula and provides no more or no less protection that the old formula had. CHAIR DUNLEAVY reiterated that the PFPA is still statutory and amounts could be vetoed, and the Legislature could change it in a 90-day session. He commented as follows: What we are lacking right now from my perspective, just from the feedback I'm getting, is a confidence in the public that we are going to deal with this in a manner that they thoroughly understand and potentially could accept, but they are wading through the terms, the terminology, the nuances, and some of this stuff they are questioning. 4:19:25 PM COMMISSIONER HOFFBECK summarized the plans to draw from the permanent fund by addressing the current status quo option, drawing from the permanent-fund-only option, and the differences in using either SB 21 or SB 26 as follows: · Status quo will eventually deplete the earnings reserve and there won't be a dividend or money for government expenditures. · Permanent-fund-only plan has the same problems as status quo if there is not a full-fiscal solution. The earnings reserve will eventually be depleted and you won't have money for government services. · Whatever plan is selected needs the rest of the pieces to solidify either of the plans. · Both SB 21 and SB 26 are rules based. · Both SB 21 and SB 26 stabilize the investment-income piece by using the five-year-averaging strategy that will take the wild swings out of it. · SB 21 does not have the shut-off valve on the percentage of market value (POMV) draw and potentially may result in super-heated spending if oil production or oil prices rebound. · Total revenue is addressed more within SB 26, but only mid- range oil prices is addressed. Once oil prices move past the mid-range, oil-price volatility could still be present. Other revenues that are part of the total fiscal package would not be addressed in SB 26, the bill only addresses the tie between oil and the permanent fund. · Both plans are statutory. · Both plans protect the dividend. · Both plans have a formula-driven approach for the dividend. · Both plans protect the fund by at least growing at the rate of inflation. · Both plans project the fund to have similar balances 24- years out at approximately $104 billion to $105 billion. · SB 21 will have more money in the earnings reserve and SB 26 will have more money in the fund's corpus. · With money in the corpus at a 5.25 percent draw, SB 26 will generate more revenue for funding government services than the 4.5 percent draw under SB 21. COMMISSIONER HOFFBECK addressed a final comparison between SB 21 and SB 26 that referenced FY2018 as follows: · FY2018 unrestricted general fund (UGF): $4.2 billion; · FY2018 existing UGF revenues: $1.4 billion; · Planned earnings reserve account draws for UGF: ƒStatus quo: not available, ƒSB 21: $1.2 billion, ƒSB 26: $2.0 billion; · Additional measures required for a full-fiscal plan: ƒStatus quo: $2.8 billion, ƒSB 21: $1.6 billion, ƒSB 26: $0.8 billion. 4:25:40 PM SENATOR WILSON addressed the $1.4 billion in existing UGF revenues in FY2018 and asked Commissioner Hoffbeck to provide additional details. COMMISSIONER HOFFBECK replied that he believes the $1.4 billion includes the revenues that the governor proposed from the motor- fuel tax. He opined that the motor-fuel tax is only $40 million in the first year, so whether the tax is included or not does not change the discussion. COMMISSIONER HOFFBECK set forth that the $800 million "hole" that needs to be filled under SB 26 will be a heavy lift; however, the administration does not see a path to fill the $1.6 billion from SB 21. He opined that an unfunded liability is a larger threat than a too large of a draw. He said a draw can be turned down, but an unfunded liability creates the incentive for unplanned draws. He asserted that unplanned draws really put the risk and the volatility into the stability of any of the plans. 4:27:58 PM SENATOR WILSON pointed out that Commissioner Hoffbeck stated that he did not see another means to "fill the hole." He asked if he thought about "making the hole smaller" by making the size of government smaller instead of looking for revenues to fill the hole. COMMISSIONER HOFFBECK answered yes. He explained that the governor intentionally did not "fill the hole" when he presented his budget because he thought a discussion was needed regarding how much is going to be revenue and how much is going to be expenditure reductions. He asserted that "everything is on the table." He opined that the $1.6 billion in additional measures required for a full-fiscal plan from SB 21 would require massive expenditure cuts and massive taxes. He admitted that the $800 million left from SB 26 is going to be a pretty big task in itself. CHAIR DUNLEAVY remarked that now is not the time to engage Commissioner Hoffbeck on the philosophy of reductions and the size of government. He opined that continued government spending will be above the $600 million that is projected in additional measures from SB 26. COMMISSIONER HOFFBECK said he had no further comment. 4:29:36 PM CHAIR DUNLEAVY thanked Commissioner Hoffbeck, and held SB 26 in committee.