Legislature(2015 - 2016)HOUSE FINANCE 519
04/13/2016 01:30 PM House FINANCE
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| Audio | Topic |
|---|---|
| Start | |
| HB245 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| + | TELECONFERENCED | ||
| += | HB 245 | TELECONFERENCED | |
| + | TELECONFERENCED | ||
| += | HB 249 | TELECONFERENCED | |
HOUSE FINANCE COMMITTEE
April 13, 2016
1:40 p.m.
1:40:28 PM
CALL TO ORDER
Co-Chair Thompson called the House Finance Committee
meeting to order at 1:40 p.m.
MEMBERS PRESENT
Representative Mark Neuman, Co-Chair
Representative Steve Thompson, Co-Chair
Representative Dan Saddler, Vice-Chair
Representative Bryce Edgmon
Representative Les Gara
Representative Lynn Gattis
Representative David Guttenberg
Representative Scott Kawasaki
Representative Cathy Munoz
Representative Lance Pruitt
Representative Tammie Wilson
0EMBERS ABSENT
None
ALSO PRESENT
Angela Rodell, Executive Director, Alaska Permanent Fund
Corporation; Craig Richards, Attorney General, Department
of Law; Randall Hoffbeck, Commissioner, Department of
Revenue.
SUMMARY
HB 245 PERM. FUND:DEPOSITS;DIVIDEND;EARNINGS
HB 245 was HEARD and HELD in committee for
further consideration.
Co-Chair Thompson reviewed the agenda for the day. He
explained that the meeting would be divided into 2 parts.
The first part would be a question and answer period with
Ms. Angela Rodell, the Executive Director of the Alaska
Permanent Fund Corporation (APFC). In the second half of
the meeting, members would be hearing from the
administration on modeling. Attorney General Richards and
Emma Pokon from the Department of Law would be sharing a
presentation.
HOUSE BILL NO. 245
"An Act relating to the Alaska permanent fund;
relating to appropriations to the dividend fund;
relating to income of the Alaska permanent fund;
relating to the earnings reserve account; relating to
the Alaska permanent fund dividend; making conforming
amendments; and providing for an effective date."
1:41:54 PM
ANGELA RODELL, EXECUTIVE DIRECTOR, ALASKA PERMANENT FUND
CORPORATION, informed the committee that she was available
to answer any questions from members. She had no prepared
remarks.
Representative Munoz asked if the targeted rate of return
of 6.9 percent was realistic. Ms. Rodell explained that 6.9
percent was forecasted based on current expectations
calculated by the PF consultant, Callan Associates. She
reported that the board of trustees had a targeted real
return rate in place of 5 percent without an inflation
assumption. She thought that unless the mandate changed
APFC would continue without different policy direction. The
Alaska Permanent Fund Corporation would continue to
construct asset allocations that achieved a 5 percent real
return for the fund.
Representative Munoz asked if Ms. Rodell was concerned with
the model that used a rate of return of 6.9 percent. Ms.
Rodell was concerned with expectations and wanted to make
sure they were managed. The corporation did not control the
market; the market would perform the way it performed.
Looking at FY 16, which started July 1, 2015, the state's
return for the fiscal year through the previous day was 0.4
percent. The corporation had started to recover from its
many losses taken in December, January, and February when
the market performed poorly. She reported that the equity
market had taken a substantial hit. She did not mind the
challenge of trying to hit the 6.9 percent target rate but
there was a possibility that in some years 6.9 percent
might not be reached. She emphasized that it was just a
forecasted number.
Representative Munoz asked how a lower rate than 5 percent
would affect the ability to inflation proof the fund. Ms.
Rodell was not sure she understood Representative Munoz's
question.
1:45:47 PM
Representative Munoz wondered if inflation proofing was
included in the model or if the fund was inflation proofed
sufficiently. Ms. Rodell relayed that when inflation
proofing was put into statute the fund could only invest in
fixed income assets. In order to preserve the purchasing
power of the fund inflation proofing was adopted in
statute. Overtime the list was expanded and lifted. The
board of trustees had an asset allocation that targeted
everything in the investment spectrum. She reported that 80
percent of the portfolio was naturally inflation proofed by
the type of assets invested. It could be argued that
inflation proofing was not as important as it was in the
past because so many investments naturally built inflation
into their valuation. However, inflation proofing had been
one of the mechanisms the state used to continue to build
and grow the corpus of the Permanent Fund (PF). As soon as
any value over the cost was recognized and received, it was
moved into the earnings reserve account (ERA) to be
available for appropriation. She stressed that if the state
wanted to see the corpus continue to grow, it would need to
place some of the gain into the fund. The way it had been
done in the past was through inflation proofing presently
totaling $16 billion.
Co-Chair Neuman noted that the legislature was looking at
moving the management of the Constitutional Budget Reserve
(CBR) to APFC for investment. He asked how the change would
work and what the investment return might be. Ms. Rodell
highlighted that there were specific limitations in statute
defining how the CBR could be invested and the amount of
allowable risk. The statutes reflected the state had
historically relied on the CBR for cash flow assistance
when there were revenue shortfalls. She suggested that if
the statutory limitations were not removed, the corporation
would have the same limitations on making investments as
the Department of Revenue did currently. If the
restrictions were lifted and APFC was allowed to invest
similarly to the Alaska PF, it would also be similar to how
APFC invested the Alaska Mental Health Trust Authority
dollars. They would receive a share of the same returns
that the fund and the ERA received.
1:49:51 PM
Co-Chair Neuman thought that generally APFC made prudent
investment decisions. He asked if the same sideboards would
be used in investing the CBR. Ms. Rodell responded in the
affirmative.
Co-Chair Neuman commented that some of the estimates of the
ERA would be about 6.0 percent. He wondered if it was a
practical number. Ms. Rodell responded that if the state
planned to draw on the CBR in the next few years, the
number might be too high. The statutory constraints
currently in place required that if the fund was to be used
within 5 years it had to stay in fixed income and liquid
assets, the returns of which well below 6.0 percent
presently.
Representative Kawasaki asked about Callan Associates'
prediction of 6.9 percent. He relayed that their report,
based on a 10-year forecast, showed the rate of return
prediction falling between 6.56 and 7.2 percent. Year-to-
date, the return rate was -3.72 percent. He restated Ms.
Rodell's conservative estimate of 5 percent. He wondered if
the legislature was receiving information that she thought
was wise. He had been hearing that the information might
not be coming directly from the PF.
Ms. Rodell clarified that 5 percent was a real return
without an inflation assumption attached. Assuming
inflation was going to be 2 percent, the nominal return
would need to be 7 percent to reach a 5 percent real
return. Callan's numbers included an inflation assumption.
The challenge with forecasting markets was that it resulted
in a forecast. Although Callan had tremendous access to
research, they reported missing their target every time. If
perfect information were available, everyone's jobs would
be much simpler. She concluded that the forecasted numbers
needed to be taken with a grain of salt. Her response to
Representative Munoz was that in looking at 6.9 percent
there was an equal chance of going above or below the
number. She emphasized that in the following years she
would be starting at .4 percent. She thought it was
unlikely 6.9 percent would be reached for FY 16.
1:53:42 PM
Representative Kawasaki thought the information was
important for the committee to hear. He noted that the
current assumed asset allocation (17 percent US equity, 24
non-US equity, etc.) was of significance. Ms. Rodell had
also mentioned policy changes coming from the legislature
in terms of the 6.9 percent rate. He wondered if she could
speak more on the subject of what could be done.
Ms. Rodell responded that there were specific directions to
preserve purchasing power to maximize income in APFC
statutes. There was specific direction given to the fund to
ensure that the fund was available for current and future
generations of Alaskans. The associated portion of the APFC
statutes was not being amended in any way by any of the
bills presented. The message that APFC was taking away was
to continue doing what it had always done until the
corporation was directed through statute to do something
different. She added that the corporation was not going to
do anything differently to meet the 6.9 percent mark. She
had not seen anything about 6.9 percent in statute or in
the proposed bill. She reiterated that the corporation had
not been directed or seen anything in the current
legislation to change the way it was doing business.
Representative Kawasaki asked if Ms. Rodell would change
the way in which the corporation operated if the
legislature wanted to change the statutes surrounding the
PF to maximize the return. Ms. Rodell replied that to some
degree she would. She furthered that obtaining a maximum
return was different from maximizing income. It would
change to a degree and would be the subject of a long
conversation with the board of trustees in terms of how to
achieve maximum returns. Additional risk assumptions would
likely have to be taken that might not be acceptable. The
Alaska Permanent Fund Corporation tried to balance the need
for income with the need for measured risk.
1:56:59 PM
Vice-Chair Saddler asked if HB 245 raised any concerns as
to whether the PF status under the Internal Revenue Service
(IRS) was tax-free. He wondered if the legislature should
have any concerns. Ms. Rodell replied in the negative. She
thought the bill would potentially make the state's
arguments with the IRS more straight forward.
Vice-Chair Saddler asked about the significance of the
change in Section 4 specifying the definition of net income
and outlining when the income was realized and received.
Ms. Rodell reported she had spoken with the staff of the
chairs in both bodies about the language. The Alaska
Permanent Fund Corporation preferred that the language be
changed back to the language currently in statue. The
corporation was concerned about how the action would be
interpreted by auditors. She suggested that it was much
cleaner to keep the current language as it existed in
statute based on the historical opinions on realized
income.
Vice-Chair Saddler wanted to have a better understanding of
the potential issues the auditors might take up. Mr. Rodell
replied that when the PF was created the constitutional
amendment creating the fund stated that income "shall go"
to the GF. At the time, under generally accepted accounting
principles, income was only realized income. Subsequent to
that time, GAP changed the definition of income to include
realized income, unrealized income, and loses. The Alaska
Permanent Fund Corporation had to get a number of legal
opinions from the attorney general to determine what it
could and could not recognize in the ERA. The auditors
relied on the legal interpretations when auditing the fund
to ensure that the state was booking income correctly and
getting a clean audit opinion. Potential confusion was
created in changing the language about what it meant to be
received. Under GAP, income was recognized not when it was
received, hence why there was unrealized income. The idea
was that once the income was receive it would be available
for appropriation. Under GAP, income was unrealized and
realized. She reemphasized that the PF Corporation would
prefer to leave the language alone to prevent any
confusion.
2:00:53 PM
Vice-Chair Saddler noted there was a section on the charts
from the Legislative Finance Division (LFD) that talked
about the percent of the investment return realized. He
also asked about the absorption of the Amerada Hess fund
into the corpus or the earnings reserve account (he could
not remember which account) and whether they created any
concerns for her regarding legal, accounting, or management
issues. Ms. Rodell responded in the negative. She thought
that absorbing the Amerada Hess fund would make things
cleaner for many people.
Vice-Chair Saddler referred to the first section of the
bill where it talked about a 3-year reevaluation clause. He
wondered if it raised any concerns for Ms. Rodell regarding
the durability of the new regime. He asked if she had any
comment on that section of the bill. Ms. Rodell responded
in the negative. Her expectation was that she would be
before the legislature every year to discuss the earnings
and the performance of the PF fund. She suspected that
there would be a significant amount of ongoing review of
the fund. She did not have any problems with the language.
2:02:29 PM
Representative Edgmon referred to the models presented in
the previous day. He wanted to discuss inflation proofing.
Three of the four models the committee had were predicated
on a 6.9 percent investment return and the fourth was based
on a return of 7.45 percent. He note that the inflation
rate built into the models was 2.25 percent. He referred to
her comment that a 6.9 percent return might be ambitious.
Based on that comment, he asked her to speak to the
potential difficulties of inflation proofing the fund going
forward.
Ms. Rodell stated that if a 2.25 percent inflation
assumption was removed from a 6.9 percent return rate about
4.7 percent would be left and would fall under the targeted
real return of 5 percent. She offered that the challenge
was recognizing reality versus forecasted numbers. The
state would do its best to achieve its targeted percentage
return under current market conditions. However, the
legislature could appropriate inflation proofing. The
corporation could also seek an inflation proofing
appropriation if it was integral to the corpus of the fund.
For instance, if the fund earnings were significantly
higher than anticipated they could be placed into the
corpus. She thought there would be ongoing discussions when
the annual evaluations were completed.
Representative Edgmon talked about half of the funds for
the PFD being tied to royalty payments under the proposed
legislation. In essence, the legislature would be
redirecting some of the volatility to the funding of the
PFD. The dividend would be based on annual royalty, the
price of oil, and production. He invited her to discuss the
change and whether someone one the street should be worried
their PFD was being placed in front of traffic versus being
funded by the fund itself.
2:06:34 PM
Ms. Rodell thought it was an interesting debate about where
the PFD was tied - tied to the fund versus tied to
royalties. She relayed that payments over the previous 4
years - dividends paid since 2011 - there had been great
volatility in the dividend because of market volatility
affecting the fund. She was unclear whether individuals
would experience new or different volatility, having
already experienced it in the past. The feedback for the
prior PFC Director and as the previous DOR Commissioner
people understood the volatility and understood that there
were market losses resulting in lower dividends. She
reported that 2 years prior the dividend was less than
$1000 and in the previous year, it was up to $2000, a huge
swing. She suspected that the dividend amount might be
smaller but steadier with a portion of the payment coming
from royalties. The Alaska Permanent Fund Corporation did
not run any models on the dividend and was not responsible
for the dividend program itself other than making one
transfer annually.
Representative Guttenberg suggested that if something went
wrong with the modeling Ms. Rodell would feel some heat
regardless of her actions or the success of the fund. He
wondered if she had concerns with the bill or the modeling.
Ms. Rodell struggled to answer the question because it was
difficult to know where and how the heat would be applied.
She thought that it was the nature of the beast. Her plan
sitting before the committee in the present was to be able
to explain what the corporation was doing and why. The
legislature might not like her responses, but the fund was
known globally for its transparency and was often commended
on its translucence. She thought it was the best counter to
any heat the corporation might receive. The potential heat
could result from spending the earnings reserve account
faster than the corporation could earn money due to low
market conditions for extended periods. The fact that there
were provisions of a 3-year review and that the legislature
had the power of appropriation gave her comfort. He
indicated he would address his questions regarding modeling
with the Department of Revenue.
2:11:04 PM
Co-Chair Neuman referred to a letter dated December 24,
2015 that suggested an earnings target of 7.5 percent (or
7.45 percent) for the PF in a deterministic model. He asked
if she agreed with the percentage rate using that
particular model. Ms. Rodell was uncomfortable using that
high of a number. She understood modeling, and
deterministic and probabilistic models and the risks
incorporated into such models. However, her individual
personal experience was that no matter how well modeling
was done it was inaccurate most of the time. She was
uncomfortable with that high of a return.
Co-Chair Neuman asked her to propose a conservative number
or goal. Ms. Rodell relayed that she kept her focus on the
real return of 5 percent. In looking at the current year's
inflation of 0.12 percent, the nominal return would be just
over 5 percent. If the inflation rate was 2.25 percent, she
would be looking at 7.25 percent. She was most comfortable
with the targeted real return assumption that had been
executed and resolved by the board of trustees rather than
what the potential might be even though capital market
indicators predicted certain returns over a 10-year period.
Co-Chair Neuman was looking for a suggested modeling
number. He would rather use more conservative numbers in
modeling. Ms. Rodell was uncomfortable with providing an
exact number outside of 5 percent.
Vice-Chair Saddler asked her to provide circumstances that
would justify limiting the PF appropriation capping the
total amount of the earnings reserve balance. He asked if
an automatic limit on the dividend distribution, based on
the balance would kick in after several years of poor
returns. Ms. Rodell responded in the Affirmative.
Vice-Chair Saddler asked if she had seen the model with
inflation proofing included. He mentioned that the charts
he had seen were reflective of nominal numbers. Ms. Rodell
had not seen the model run with real target returns as
opposed to nominal target returns.
Co-Chair Thompson thanked Ms. Rodell for her testimony.
2:15:23 PM
CRAIG RICHARDS, ATTORNEY GENERAL, DEPARTMENT OF LAW, made
himself available to the committee for questions. He
referenced a letter handed out regarding the
administration's comments on the proposed committee
substitute (CS). He relayed that he would be walking
through the short PowerPoint presentation from the
Department of Revenue on some modeling results and would
discuss the major points in the letter. He wondered if the
chair was agreeable to his agenda.
Co-Chair Thompson encouraged Attorney General Richards to
continue.
Attorney General Richards introduced the PowerPoint
Presentation: "Analysis for House Finance CS for HB 245 by
Department of Revenue's Economic Research Group 4/12/2016."
He explained that the first few slides condensed what the
bill did and what assumptions were used in the modeling. He
confirmed that the administration had modeled what was in
the bill. The modeling included the dividend payout
calculation using a 5.25 percent payout rate. He relayed
the conclusions from the Department of Revenue in three
senses. The first was what the dividend would look like
over time under the modeling in the bill. The second was
what the value of the PF itself look like over time. The
third was what he revenue stream going to the general fund
over time look like. He thought the conclusions were
relatively similar to what the Legislative Finance Division
(LFD) came up with as expected with the assumptions. In
particular, the assumption he thought had the most
controversy around it in relation to the bill was what
return assumption was used.
Attorney General Richards continued that the information
presented the previous day had two return assumptions: one
at 6.9 percent total geometric returns and one at 7.45
percent. He relayed that the administration had used, and
would continue to use 6.9 percent because one of the major
things the state asked McKinsey and Company, a private
consulting firm, to provide its best opinion as to what
return assumption should be used. He reported that the
company had spent several weeks going through the different
options, forecasts, historical data, and the different
models of returns and return assumptions used by the
Department of Revenue and Callan Associates. McKinsey and
Company concluded that the best available information to
use for modeling purposes was Callan Associates' 10-year
forecast in its deterministic model at 6.9 percent. He
relayed that using 7.45 percent was not recommended by
experts who evaluated the problem for the administration.
Attorney General Richards scrolled to slide 6: "HB 245 CS
at 5.25 percent POMV Per Person Dividend Size." He reported
that when DOR modeled the dividend using the 6.9 percent
total return, the dividend stayed flat at about $1000 at
the mean. He highlighted the yellow and blue bars where
they intersected. The intersection represented the fiftieth
percentile outcome; the average outcome for each of the
years represented in the chart. In reference to the blue
bar, he relayed that there was a 25 percent chance that the
outcome would be above the average to the top of the blue
bar. There was also about a 25 percent chance that the
outcome would go all the way to the top line above the blue
bar. Similarly, there was a 50 chance that the outcome
would go in the yellow box and the line below the yellow
box. He explained that the reason there was so much
variability was that even though 6.9 percent was the mean
on the returns it would vary widely over time with the
stock market potentially the stock market performing in a
number of different ways. He remarked that it was a long
way of saying the mean expectation of DOR was that the PFD
would be about $1000 flat overtime under the proposed
committee substitute. He noted that the committee
substitute met the governor's targets.
2:20:23 PM
Attorney General Richards pointed to there being more
upside in the dividend over time than there was downside.
In other words, the chance of the dividend amount being
higher was more likely based on two components. The first
component of the dividend was that it would be based on a
POMV. Due to the expectation of the fund value growing over
time, the dividend would also grow for one half of the
component. The other half of the component was the royalty
component, which was likely to be larger than it was
presently because of low oil prices. Currently, 20 percent
of royalties was a relatively conservative number compared
to what it would be if oil prices increased significantly.
In response to Representative Edgmon's question about
whether the proposed dividend formulation more or less
volatile than the current on, the administration had not
modeled it. He would ask someone from DOR to look at it. He
suspected it would be less volatile than the current
dividend. He explained that by basing the dividend on the
POMV versus on the earnings, the number was much less
volatile.
Attorney General Richards turned to slide 7: "HB 245 CS @
5.25 percent POMV Total EOY Fund Balance." He suggested
that if the 6.9 percent return assumption was used, the
5.25 percent POMV draw was too aggressive if the goal was
to maintain the real value of the fund. He conveyed that on
an inflation adjusted basis the 5.25 percent would degrade
the purchasing power of the fund over time in the median
case. He emphasized that he stated "the median case." It
was possible that things would change substantially and the
fund would grow considerably. Conversely, things could
change negatively such that the stock market could perform
poorly and the fund could shrink substantially. The chart
showed a range of what the fund might look like. He noted
that the mean value of the fund under a 5.25 percent draw
was projected not to meet up with inflation. However, there
was still much more of an upside in growth than there was a
downside due to interest turning compound over time. If
there were a good series of runs, there would be a
compounded growth effect.
Attorney General Richards turned to slide 8: "HB 245 CS @
5.25 percent POMV: Net Payout to GF plus Production Taxes
and Royalties not dedicated to the PF or Dividend." He
explained that with a basis of 6.9 percent total returns
the administration did not believe the growth of the PF
would be equal to inflation. It also meant that the amount
of money that went to government would decrease over time.
He concluded that by degrading the value of the fund in
real terms, it would also degrade the value of the cash
flow that went to the government over time.
Attorney General Richards mentioned there were other things
worth looking at in terms of modeling that would be
provided in the following couple of days. Some items
included looking at how the modeling would work with
certain revenue limits and at volatility in relation to the
current dividend.
2:24:12 PM
Representative Edgmon commented that if he were to take
what Attorney General Richards presented at face value, it
contradicted what the director of APFC had told the
committee earlier about rate of returns. However, he knew
it was more complicated. He asked if the model encompassed
in HB 245 was based on a 6.9 percent rate of return. He
wondered if the number captured the variability with oil
production and oil prices and therefore, provided more
comfort to rising above the 5 percent the Ms. Rodell had
stated she was more comfortable with based on her own
experiences. Attorney General Richards indicated that the
board had set a real rate of return expectation of 5
percent - the return not counting inflation. The total
return rate of 6.9 percent included both the real return
component and the inflation return component. If the real
return target was 5 percent and inflation was anticipated
to be 2.25 percent then the total return expectation would
be 7.25 percent. If 2.25 percent was a reasonable inflation
estimate then the 6.9 percent total return that Callan
Associates used was more conservative than the board's real
expectation.
Representative Edgmon was grappling with the question of
variability of oil price and oil production. He was
concerned with the performance of the endowment fund.
Attorney General Richards relayed that the modeling being
reviewed did not account for the variability of oil prices
because the current CS did not deal with volatility, as the
administration would suggest was appropriate. He noted he
would be making some recommendations on how to amend the CS
to handle volatility. That modeling would include oil
prices. He noted, however, that under the constitution 25
percent of royalties were going to the corpus under any
plan. The modeling took into account oil prices as it
influenced the 25 percent of the constitutional royalty
influx into the corpus.
2:27:34 PM
Attorney General Richards reported that the administration
was pleased with the committee substitute. He commented
that it was a well thought out and well-designed bill that
adopted an approach that the administration could support.
He suggested there had been a great collaboration. One of
pieces of the bill that the administration wanted to
highlight that made sense was talking about a
sustainability target in the same kind of way that the
state should maintain, at a minimum, the real value of the
fund over time. One of the governor's core goals was that
the value of the PF not be degraded. The administration
thought that the original Alaska Permanent Fund Protection
Act (APFPA) had proposed drawing a fixed amount of $3.33
billion versus a POMV. The administration had indicated
from the beginning that the POMV was a great approach that
worked. He thought adopting a POMV approach was very
reasonable. The governor was in support of the royalties
being tied to the dividend. He thought it made sense to
have Alaskans rewarded when the state's natural resource
economy was doing well. As Alaska did well and the budget
did, the dividend would go up. On the other hand, the
administration recognized that there was utility and value
in having the people of Alaska staying connected to the
direct performance of the fund itself. The dividend
calculation achieved both. It tied people to the success of
Alaska's resource economy and it tied people to the success
of the PF. In terms of the absolute amount of the dividend,
the governor has said that a dividend of around $1000 was
an appropriate amount. The specific calculation in the bill
was projected to provide.
Attorney General Richards reported that another item in the
committee substitute that made sense was to repeal the
Emerita Hess provisions. They were an artifice of old
litigation and were not necessary legally or from an
accounting perspective. He thought the administration would
support a statutory change that would allow the CBR to be
invested more long-term to achieve higher returns. He noted
the administration would likely pass on some technical
comments regarding the language of the bill, which would
not be substantive. (Attorney General Richards referred to
a letter addressed to Co-Chair Thompson dated April 13,
2016 - Copy on File).
Representative Wilson wanted to understand better why
citizens would favor benefiting when oil prices increased
and not benefiting when oil prices decreased. Government
already benefited because the state had its highest years
when oil was over $100 per barrel. The state already
experienced large spending years. Currently, things were
reversed and the state had to come into check. Alaskan
residents would benefit from the PFD but at present, the
state wanted to change the game. She asked if the attorney
general saw an issue. Attorney General Richards responded
that he did not see an issue. He understood that having the
dividend system tied to the earnings was really a system
designed to incent Alaskans to protect the fund, which
included not spending the fund and encouraging its growth.
He did not believe there was anything inappropriate about
tying the dividend to the natural resource economy
currently or in the future. He thought either was rationale
and that a policy decision was required. He suggested
policy makers needed to consider what made sense in terms
of incenting and rewarding Alaskans going forward.
2:32:48 PM
Representative Wilson commented that the attorney general
had obviously not gone door-to-door. She stressed that it
would be very difficult to explain to constituents the
state taking their money when the price of oil was high and
changing the rules. Currently, the price of oil was low and
it did not appear that it would rebound. She suggested that
instead of reducing its spending, the state was going to
take what belonged to the people. She asserted that the
bill sought to fill the gap using a different formula. The
model showed the public contributing indefinitely while the
state continued to spend. She opined that she would have a
tough time selling the plan to her constituents.
Attorney General Richards responded that there were two
parts to the conversation. The first part had to do with
what formulaic method to use to calculate the dividend. He
thought it would reflect the volatility in the dividend.
The other part of the conversation was about the size of
the dividend. His answer was that it was rational to change
the method of calculating the dividend. He claimed that in
moving to a POMV it was not possible to do an earnings-
based dividend, as it did not make sense. He remarked that
Representative Wilson's question went to not just how the
dividend was calculated but also how much the dividend
should be.
Representative Wilson clarified that she was uncomfortable
in deciding the amount of the dividend. She did not want to
choose a random number to fill the state's gap. It was the
people's money. She wondered how to justify picking a
number. Attorney General Richards answered that from the
administration's point of view the state had a system that
was unsustainable. The governor believed that in order to
move to a sustainable system, the state would need to press
down evenly. He had tried to balance reducing the dividend,
increasing revenue measures, reducing oil and gas tax
credits, and introducing spending cuts. He tried to design
a system that spread the pain. Reducing the dividend was a
necessary component because of its magnitude. In order to
protect the dividend in the future there needed to be a
plan that reduced the cost of the system and increased
revenues. As Mr. Teal has stated before, without a plan the
state would be broke by FY 21.
Representative Wilson responded that the only reason Alaska
would be broke was if the state continued to spend at the
same level as it did presently. She mentioned hearing from
Mr. Keithly earlier in the day and Mr. Goldsmith previously
that there was another path to a sustainable budget. It was
suggested that the state use a portion of the ER and some
of the other state savings. However, the state had to save
money for the plan to work. She asked if the
administration's plan had triggers such as oil prices going
up placing a limit on the amount government could spend.
Attorney General Richards asked to postpone the answer to
her question. He would be covering it later in the slide.
Representative Wilson agreed to wait.
2:37:42 PM
Attorney General Richards reported having reviewed what the
administration considered positive aspects of the committee
substitute. The administration would provide some suggested
small technical amendments. However, the administration
identified three aspects of the bill that could be
improved. First, the administration thought 5.2 percent was
slightly too aggressive in the current form of the bill. He
relayed that a POMV percentage of 4.9 or less would meet
the sustainability requirement.
Attorney General Richards' second point was that the
administration believed it was good policy and appropriate
to have an inflation proofing mechanism in place. He
explained that in the current system all of the realized
gains came out of the corpus of the PF into the ER. By
statute, an amount dedicated to inflation proofing was
placed back into the corpus of the fund. He suggested that
without a system, not necessarily the present system, the
growth in the PF over time would occur in the ER rather
than in the corpus. The administration believed it was
appropriate to have a durable earnings reserve that was
large enough to be able to make the sustainable draws that
would be expected of it. Any excess funds would return to
the corpus to protect the principle and the corpus of the
fund, which would grow over time for future Alaskans.
Attorney General Richards continued that the original bill
recommended getting rid of the existing inflation proofing
mechanism. However, it added a provision stipulating that
once the ER got four times larger than the current year
expected draw, anything in the ER above that amount - about
$10 billion in the proposed bill - would be transferred
back to the corpus. It provided for a type of inflation
proofing that grew the corpus over time but left the state
with a durable ER. He further explained that Mr. Teal and
Mr. Dell talked about the change in the nature of
allocations and PF investments. The change included moving
away from investment bonds to holding stocks, real estate,
and private equity; things that appreciated in value, but
were not recognized as income right away. Eventually, over
time the state would realize its gain on all of the assets
when they were sold. The occurrence of capital appreciation
in investments currently reflected in the corpus upon sale
would go to the ER. If the state was going to have the ER
continue to grow, and maintain its size over time there had
to be some mechanism that would allow money to go back from
the ER to the corpus. Otherwise, the ER would experience
the growth over time and the corpus would not. He concluded
that it was better policy to protect generationally the
money by having the growth in the corpus rather than the
ER.
Representative Pruitt asked how long it would take to get
to the $10 billion figure. Attorney General Richards
responded that he had not seen the modeling for the current
CS. However, under the original proposal the best estimate
was about 4 years. If things turned out better, like the
stock market jumping significantly, it would only take a
couple of years. The same applied if oil revenues jumped
up. In boom times, it was a way of capturing the excess and
transferring it to the corpus.
2:42:22 PM
Representative Munoz asked if it was a combination of
having a larger draw from the CBR into the corpus of the
account, thus generating more revenue. Attorney General
Richards responded affirmatively. The governor's original
proposal in the APFPA was to take $3 billion from the CBR
and place it in the ERA. By doing so, it allowed the state
to invest the $3 billion for a longer period to get better
returns and increasing the state's sustainable take. It
also buttressed the size of the ER to make it stronger. He
relayed the governor's plan was not necessary, but it
provided a higher degree of confidence. Under the committee
substitute, because the draws were smaller, it made it less
necessary to do so. Having a $3 billion-transfer was
favorable, but it was not necessary to have a durable ER.
Attorney General Richards mentioned that over the previous
6 months the administration had talked about the issue of
volatility. In particular, he noted volatility associated
with the state's three major sources of cash flow including
earnings of the PF, production taxes, and royalties. The
plan managed the volatility associated with the earnings of
the PF by adopting a POMV approach. The state would not
spend the earnings every year, but rather a proxy for the
earnings, which was a percentage of the market value - a
steady number. The governor's plan had proposed applying a
similar approach to production taxes and royalties by
placing those cash flow streams into the earnings reserve
account and spending a fixed amount every year. He
suggested that with this approach when oil prices were
high, the state would save more. Conversely, when oil
prices were low, the state would spend more. The
administration thought it was a good approach and worked
with a POMV. Whereas, the governor's plan stated that $3.3
billion was a sustainable amount if petroleum revenues were
placed in the ERA. The petroleum revenues could still be
placed in the ERA and the POMV draw could be increased. It
was another way of having a steady cash flow coming out of
the PF to fund government while harnessing the volatility
of the three cash flow systems. The economic modeling
showed the sustainable POMV percentage at roughly 6.5
percent if production taxes and royalties were placed into
the ERA.
Attorney General Richards reported that another approach
the administration supported was the revenue limit that
resulted from an amendment to SB 114 [Legislation
introduced in 2015 - Short Title: PERM FUND: EARNINGS,
DEPOSITS, ACCOUNTS] out of the Senate State Affairs
Committee. He explained that if oil prices rebounded, then
to the extent they rebounded the state would not be drawing
from its financial assets. It was another logical way of
handling the real problem of volatility. The problem with
volatility was twofold. First, state revenues jumped up and
down, which propagated government growth in good years and
significant government shrinkage in bad years. He surmised
that the revenue limit adopted by the Senate State Affairs
Committee addressed the issue. It also addressed the other
piece of volatility, which was a pure POMV. In the
committee substitute, the state would be able to turn on
the PF faucet to move money into the GF. If oil prices were
to rebound, the state could potentially build budgets not
only on high oil prices but also on large draws from the
PF. It would be akin to doubling down on oil price
volatility. In the next period of oil price collapse, the
government would have built a larger and more unsustainable
budget then without PF revenues being accessible. He
concluded that the governor thought the inflation piece and
the volatility piece (the lack of a revenue limit) could be
improved substantially.
Representative Thompson welcomed Commissioner Hoffbeck to
the meeting.
2:47:41 PM
Attorney General Richards addressed the issue of a rule-
based system around a revenue limit. He noted that Mr. Teal
had mentioned the previous day that a revenue limit was not
necessary because funding was subject to appropriation. Mr.
Teal had indicated that the rules could be changed by the
legislature, although he was uncertain they were necessary.
Instead, Mr. Teal offered that everything could be handled
by a yearly appropriation.
Attorney General Richards pointed to a chart titled "Long-
Term Problem" from the Alaska Permanent Fund Protection
Act: Defining the Problem (one-page handout from a previous
presentation - labeled page 10). He offered that the chart
demonstrated the state's unrestricted budget graphed
against unrestricted petroleum revenues. It showed a high
statistical correlation to the amount the state spent and
the amount of petroleum revenues that were collected in the
prior year. He furthered that when petroleum levels were
high, the state spent a significant amount of money. He
continued that when petroleum revenues were low the state
spent less money. It was an extremely high statistical
correlation. He furthered without a rules-based system it
was likely the legislature would spend the petroleum
revenues available if history repeated itself. He suggested
comparing his handout to the history of the PF. He thought
members could see the value of a rules-based revenue limit.
In roughly 35 plus years, the legislature had never broken
a rule regarding the PF. The state had inflation proofed,
paid dividends, and kept from spending the ER, all of which
could be done by a majority vote by appropriation. He
claimed where a rule-based system was not in place, there
was an extremely high tendency to spend money. In a rules-
based system, there was incredible discipline in following
the rules. He furthered that when a system needed to be
changed, if there was a rules-based revenue limit the
discussion would not be about taking money out of the PF
but about changing the rules in a sustainable manner. He
surmised that by having the rules in place the topic of ad
hoc spending would be avoided. He advised that the state
would want to avoid ad hoc spending with its financial
savings and sovereign wealth funds because it would prevent
the state from growing its savings over time in a
sustainable system.
Representative Wilson asked if there had been any modeling
done with the entire package. She indicated that the bills
were being heard separately. She did not have a picture of
the impact of a total package. She wondered if the
department had done modeling for different groups in
different demographics. She wanted to have a bigger picture
of the impacts of the total plan.
RANDALL HOFFBECK, COMMISSIONER, DEPARTMENT OF REVENUE,
replied that the department had not done a model of the
cumulative impact of the various components on an
individual taxpayer. The department had modeled it in
aggregate. Gunnar Knapp had done the modeling and presented
it to the committee. The department had not drilled down to
the level Representative Wilson queried, such as a
particular fisherman in a certain community.
Representative Wilson asked how long it would take to
produce a model. Commissioner Hoffbeck thought some kind of
modeling could be done with a selection of six proxy
individuals in the state with a certain occupation.
Representative Wilson stated that the legislature kept
hearing about being fair to everyone in the state and
sharing the pain. She wanted to have a better understanding
of the full impact of what was being proposed. She thought
more people would leave the state. She did not have a grasp
of how everything that was on the table would affect
people's choices to stay in Alaska or leave the state,
especially those folks in areas with higher energy costs.
Commissioner Hoffbeck could produce a model, but thought
there was a much larger picture to consider. There would be
an impact if the state cut an amount from the budget, a
certain number of people lost their jobs, people left the
state, and house prices dropped. He could provide a simple
model but it would be very difficult to model fully how the
changes would affect an individual in the state. Everything
the state did would have some impact whether it reduced its
expenditures or increased its revenues.
2:55:50 PM
Representative Wilson understood the commissioner's point.
She thought private businesses were already doing it. She
was concerned with taxes stacking up. She commented that it
[the plan] would have a huge impact: it would not only
impact a family's income, but would also affect Alaskan
communities. She was trying to measure the different items
in the last few days [of the legislative session].
Representative Munoz returned to the rules-based system and
the importance of having rules pertaining to spending. She
wondered if the POMV approach was a rules-based system. If
it was not, she wondered what the state would need to
recalculate the spending amount to put the rules into place
in the current legislation. Attorney General Richards
replied that the POMV was definitely a rules-based system.
He asserted that the bill did not contain all of the rules
he thought it needed. The committee substitute had a rule
for how much could be drawn from the PF. He remarked it was
a good rule, but perhaps slightly too high. It had a rule
for how dividends were paid and rules for how the PF was
managed consistent with existing rules. They were all part
of a rules-based framework. He expounded that it lacked a
rule to address a revenue limit in the volatility issues.
He was not suggesting that it was not a rules-based
framework. However, it left out one of the necessary rules
for the framework to be robust that did not result in the
state just spending PF earnings if oil prices increased to
previous levels.
Representative Edgmon asked Mr. Teal the previous day about
how Alaska would stand with the rating agencies. He noted
the governor and members of his cabinet meeting with the
rating agencies on the East Coast. He wondered how the plan
being proposed stacked up with the rating agencies in terms
of Alaska getting its fiscal house in order if the
legislature did not include other sources of new revenue
such as income, fishing, or mining taxes. He wondered how
the legislation would be received back East. Commissioner
Hoffbeck stated that the bond rating agencies were in favor
of the state using its earnings reserves. However, they
would negatively view the state leaving a large structural
deficit in which it continued to draw down savings. He
thought the state needed to close its deficit with the
revenue packages before the bond rating agencies would view
the plan as sustainable over the long-term. He reported a
comment offered by Moodys. There was a discussion about the
downgrade from AAA to AA+. He had shown how using the
earnings reserves would stabilize the state. Moodys was
unsure that using just the earnings reserves would create a
stable enough fiscal environment for the state.
2:59:51 PM
Representative Edgmon indicated that it had just been
mentioned that the three largest sources of revenues to the
state included production tax, royalties, and the earnings
from the PF. If current oil prices stayed within the
current low realm, $50 to $60 into the future, the state
would not have production tax revenue or would have a very
limited amount the way SB 21 [Oil tax legislation passed in
2013] was structured. The question was how it impacted
modeling. He was aware the commissioner could not provide
the exact results, but it seemed to him that it played a
substantial role if the variables he had just described
stayed in place going into perpetuity. He thought 2040 was
perpetuity. He wanted the commissioner to provide a bigger
picture view. Commissioner Hoffbeck affirmed that if the
state had sustained low oil prices in the $40 range the
state would build a credit liability. If the price of oil
ranged from $50 to $60, the state would no longer build a
net operating loss liability with the producers. Depending
upon what the legislature decided on the oil and gas tax
credit reform it would make sense to model whether the
state would have a tail of liability. It would become
another component against the oil price in production until
it was paid off. The department modeled the current price
points and did not anticipate a major shift. If the price
remained at low levels for 4 or 5 years, the department
would need to remodel. Hence, there was a systematic review
in the plan.
Representative Gara relayed that historically POMVs used a
4.5 percent payout. He understood that most trust funds did
not have a royalty as well. He thought royalties allowed
for an aggressive payout. He asked if he was accurate.
Attorney General Richards replied that he was correct. He
added that if an average lagging number were used, the
percentage would be slightly higher because of averaging in
the lower value from 5 years prior with the current value.
If only the current value was used as the percent, then 4.5
percent was the accepted number. However, if an average
were used, then a slightly higher percentage would be used.
3:03:58 PM
Representative Gara wondered about the potential for a
higher dividend payout. He thought that under the
governor's plan the payout percentage allowed for a
dividend. He asked about royalties adding to the percentage
of the PF at $30, $40, or $50 per barrel of oil. He
remarked that most trust funds did not have an extra income
stream such as a royalty. Alaska was somewhat different
because it had royalties that offset the worry of eating
into the principle of the PF. Attorney General Richards
responded that 25 percent of royalties equaled
approximately $200 million.
Vice-Chair Gara wondered if $200 million was about 1.5
percent. Attorney General Richards responded that $200
million divided by $50 billion equaled about .4 percent of
the value of the PF. He added that it was $200 million
every year. If the state treated it like an annuity, the
value of an annuity would be roughly $2 billion.
Representative Gara asked if it was safe to move the POMV
payout rate higher than 5.25 percent to achieve the desired
revenue and a better dividend. Attorney General Richards
replied that as the bill was currently constructed, a
percentage rate of 5.25 was considered a little aggressive.
He explained that the POMV percentage would not change, but
the relative amount that went to government versus dividend
checks would change through adjusting the POMV percentage
as drafted in the CS. He reiterated that one of the two
revenue limits that the administration supported would
change the POMV sustainable percentage.
Representative Gara referred to raising the dividend payout
from $1000 to $1500, which he thought would cost about $350
million. Commissioner Hoffbeck responded in the
affirmative.
Representative Gara discussed the variability of oil
prices. He stated that one of the reasons the model being
presented in the CS was more flexible than the governor's
model was because of a relief valve being present in case
oil prices rose. The governor's model had much more money
going towards the principal. He asked if there was an
objection to moving the PFD to $1500 the first year, then
revisiting the amount to judge if it was sustainable the
following year under the proposed plan. Commissioner
Hoffbeck stated that the reason for the $1000 figure had to
do with the underlying math. If $500 were added to the
dividend, it would take away $350 million from monies
available for other expenditures.
3:08:52 PM
Representative Gara advised that he was asking questions
while not yet being in support of the proposed plan. He
relayed that it would be difficult tell the public there
was a balanced plan without an oil tax credit reform bill.
He mentioned a number of wealthy individuals had expressed
not needing their PFD. He reported that unclaimed PFDs were
spread amongst other applicants was the current practice.
He asked if there was a way for Alaskans to decline their
dividend having the funds go back to the ERA. He wondered
if the administration would consider such an option so that
individuals could opt out of the dividend and grow the ERA.
Commissioner Hoffbeck suggested that Representative Gara's
idea would require a statutory change, and most likely a
ruling by the Internal Revenue Service (IRS) to settle tax
issues. He thought there might be a tax liability if a PFD
applicant was considered to be in control of the dividend
funds through making a choice to direct them to the ERA.
Representative Gara asked if Commissioner Hoffbeck would
look into the matter. He had considered the circumstances
surrounding an employee who received a bonus but declined
it. He thought the idea could result in extending the ERA.
Commissioner Hoffbeck agreed to look in to the matter.
Representative Pruitt believed that Representative Gara's
idea would be more difficult to implement. He thought there
would be a tax liability as mentioned by Commissioner
Hoffbeck. He agreed with Attorney General Richards that it
was important to find an appropriate way to make sure that
there were revenue limits and stability in the bill. He
referred to the two options that AG Richards had discussed,
and asked for more detail. Attorney General Richards stated
that the idea of a rules- based revenue limit was extremely
important to the administration in handling some budget
problems. He furthered that the limit was a way to make
sure that if oil prices recovered, the state would not
increase spending to a degree and diminish the PF earnings.
Attorney General Richards addressed the two proposals
mentioned by Representative Pruitt starting with the
revenue limit that was put into SB 114 [Legislation
proposed in 2015 - Short Title: PERM FUND: EARNINGS,
DEPOSITS, ACCOUNTS] in the Senate State Affairs Committee.
He prefaced his comment by informing the committee that
production taxes and royalties were estimated collectively
to be approximately $800 million to $1 billion in the
future. The proposal would include accessing the PF in the
short-term and building a sustainable budget plan around
the petroleum revenue assumption. If revenues were greater
than anticipated, the revenue limit would reduce the amount
that came from the ERA above $1 billion. If oil revenues
turned out to be $1.2 billion, the state would reduce the
POMV draw by the excess $200 million. The revenue limit
would prevent a budget built upon high oil prices and PF
earnings in a high oil price environment.
Representative Pruitt asked the attorney general to provide
a stable dollar amount based on how the bill was currently
constructed. Attorney General Richards referred back to
three volatile cash flows that were being managed:
production taxes, royalties, and the draw from the PF. He
relayed that together the funds were expected to total
about $3.5 billion; assuming a 5 percent POMV from the PF
and approximately $1 billion in revenues from production
taxes and royalties. The revenue limit of $3.5 billion was
a baseline from the three various cash flows. As oil prices
rose, the state would not use PF earnings to inject more
than the $3.5 billion into the GF.
3:17:08 PM
Representative Pruitt asked about the second option being
considered. Attorney General Richards explained that option
2 (initially contained in the original version of the
APFPA) combined production taxes, royalties, and earnings
from the corpus of the fund into the ERA. The revenue limit
would include a calculation that would determine a
sustainable annual draw over time that could be supported
by the three income streams. The variable cash flow streams
would be leveled to come up with a sustainable amount that
could be used to budget upon annually. He explained that
under the PFPA, the revenue limit was originally $3.3
billion; he commented that the math was very similar to
adopting a 6.5 POMV approach. He restated that if all three
income streams were housed in the ERA, the sustainable POMV
would be about 6.5 percent, which would provide a steady
annuity-like payment coming from the PF every year that
would act as the revenue limit.
Representative Pruitt wanted to understand the benefit of
moving the income streams into the ERA. He wondered if the
configuration gave opportunities for the state to invest
the funds in a more beneficial way than they would be
otherwise. He assumed the higher rate of 6.5 percent
accounted for the fact that the state would be sending more
money towards the PF. Attorney General Richards stated that
the sustainable POMV draw percentage (without putting more
income into the PF) was calculated by DOR as approximately
4.9 percent. If royalties and production taxes or any other
cash flow was put into the PF, the sustainable draw
percentage on a POMV basis would rise. In the case of
putting production taxes and royalties in to the PF, DOR
calculated the sustainable draw percentage at about 6.5
percent. The 1.6 percent difference in what was possible to
draw from the PF was a reflection of the value of the
income streams.
Representative Pruitt restated his question about the value
of and reasoning for moving the revenue streams into the
fund. Commissioner Hoffbeck explained that there was some
advantage in moving the revenues to the ERA because there
would be an intermittent cash flow in the form of a monthly
payment coming in. If the funds were housed in the GF to
pay for government services, not much could be done with
the funds beyond short, low-return investments. Conversely,
if the funds were flowing into the larger PF, the monies
could go into the standard investment portfolio and be
invested more aggressively.
Representative Pruitt asked if the scenario could be
compared to using a checking account or money market
account with a higher opportunity to make more money from
the funds.
3:22:14 PM
Vice-Chair Saddler asked about the option of citizens
declining a PFD. He asked how often the Department of
Revenue had received checks from citizens to reduce the
public debt. Commissioner Hoffbeck stated he had not seen
such a check recently.
Vice-Chair Saddler asked if such an occurrence would be
likely. Commissioner Hoffbeck answered that it would not be
likely.
Representative Wilson spoke of a constituent that was
interested in donating his PFD to help with the budget
deficit. The individual had donated money to the university
and then had to pay taxes on the PFD despite having donated
the funds. She recounted that the constituent had written
to the legislature inquiring as to how he could donate his
PFD without being taxed on it.
Representative Gara emphasized that the committee was
trying to find a way for individuals to donate PFD funds
without being taxed, rather than engaging in arguments.
Co-Chair Thompson called a point of order and surmised that
Commissioner Hoffbeck could work on the issue of a non-
taxable donation of the PFD. He set the bill aside.
HB 245 was HEARD and HELD in committee for further
consideration.
Co-Chair Thompson reviewed the agenda for the following
day.
ADJOURNMENT
3:25:16 PM
The meeting was adjourned at 3:25 p.m.
| Document Name | Date/Time | Subjects |
|---|---|---|
| HB 245 - Modeling for HFIN CS 041216.pdf |
HFIN 4/13/2016 1:30:00 PM |
HB 245 |
| Page 10 from HB 245 - Alaska Permanent Fund Protection Act (Feb 15 2016 HF).pdf |
HFIN 4/13/2016 1:30:00 PM |
HB 245 |
| HB 245 CS revenue limit (4.13.16).pdf |
HFIN 4/13/2016 1:30:00 PM |
HB 245 |
| HB 245 DOR Letter.PDF |
HFIN 4/13/2016 1:30:00 PM HFIN 4/19/2016 8:30:00 AM |
HB 245 |