Legislature(2015 - 2016)SENATE FINANCE 532
03/21/2016 09:00 AM Senate FINANCE
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| Audio | Topic |
|---|---|
| Start | |
| SB128 | |
| SB1 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| + | SB 128 | TELECONFERENCED | |
| + | TELECONFERENCED | ||
| += | SB 1 | TELECONFERENCED | |
SENATE BILL NO. 128
"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."
9:08:44 AM
RANDALL HOFFBECK, COMMISSIONER, DEPARTMENT OF REVENUE,
introduced himself and his support staff. He expressed
appreciation for the opportunity to present the bill to the
committee.
9:09:57 AM
Commissioner Hoffbeck began the presentation, "Alaska
Permanent Fund Protection Act," (copy on file). He
presented Slide 2, "Overview":
· Defining the Problem
· Fiscal Policy for Oil Economies
· Analysis of Options APFPA Summary
o Defining "Sustainable"
o How to Handle the Draw
o How to Handle the Volatility
o How to Handle the Dividend
· APFPA Sectional Analysis
Commissioner Hoffbeck believed that the bill attempted to
solve the subtleties of the state's fiscal problems.
9:10:36 AM
Commissioner Hoffbeck presented Slide 4, "Defining the
Problem":
· Short-Term:
o Drop in oil prices has resulted in large budget
gaps
· Medium-Term:
o State savings will be spent in about 4 years
o Uncorrected, state budget hole will damage
Alaska's economy
o Dividend payments are unsustainable under the
status quo
· Long-Term:
o State's undiversified budget is highly
dependent on petroleum revenues
o There has been a declining trend in North Slope
petroleum production
o Cyclicality in petroleum prices creates an
unstable state budget and economy
9:11:04 AM
Commissioner Hoffbeck discussed Slide 5, "Short-Term
Problem," which depicted a bar graph entitled "Alaska's
Unrestricted General Fund Revenue." He remarked that the
slide depicted the petroleum and non-petroleum revenues of
the unrestricted general fund (UGF).
9:12:04 AM
Commissioner Hoffbeck remarked that the UGF revenues were
primarily driven by petroleum revenue, which made them
volatile. He pointed out the variance between 2012 and
2016. In 2012, the state had approximately $9.5 billion in
UGF to use for funding government services; conversely in
2016, the projected revenue was $1.3 billion: an $8 billion
decline in a 4-year period of time. He noted that the
decline had created a budget shortfall, regardless of
mitigating factors such as savings and budget cuts. He
lamented that the state faced a substantial revenue
shortfall of approximately $4 billion.
9:13:46 AM
Commissioner Hoffbeck turned to Slide 6, "Medium-Term
Problem," which plotted the state budget, in nominal
billions; by existing revenue; short-term savings
(CBR&SBR); and withdrawals from permanent funds earnings.
He said that although during times of smaller deficits the
state had been able to bridge the shortfall by spending
savings, state savings would not last to cover the $4
billion deficit. He relayed that if no adjustments were
made under the current scenario, the state would spend down
the CBR by 2018; the earnings reserve would be depleted by
2021. He discussed the benefits of not spending down state
savings during the current time of fiscal crisis; the first
benefit being the fiscal certainty that savings provided,
and secondly, that the savings could be a primary driver in
the state's long-term sustainable income. He summarized
that the goal was to balance the budget and create a long-
term sustainable plan, while preserving savings.
9:15:19 AM
Commissioner Hoffbeck moved to Slide 7, "Long-Term
Problem," which showed a line graph illustrating the
volatility of a government funded primarily by a commodity
based asset. He pointed out to the committee that
government spending had tracked with the amount of money
available for expenditure. He relayed that the bill was an
attempt to take the volatility out of the budgeting
process, which he believed would benefit the state's
economy in the long-term.
9:16:26 AM
Senator Dunleavy believed that the discussion was about the
state's operating budget having grown with revenue, but not
dropped correspondingly, he queried whether the budget
could be reduced from current levels in order to align with
current revenues.
Commissioner Hoffbeck thought there were several dynamics
at work; the budget had been relatively flat for 20 years,
which had put stress on government services and
infrastructure, and had deferred other expenses. He said
that the administration had worked to trim the budget, as
well as the House and Senate Finance Committees. He
lamented that inflation, raising medical costs, and higher
employee costs had kept the state from reducing the budget
to lower levels.
9:18:54 AM
Senator Dunleavy asked whether the possibility of new
revenues would keep legislators and the administration from
significantly cutting the current budget.
Commissioner Hoffbeck did not believe that the possibility
of new revenues would psychologically trick lawmakers or
the executive branch from seeking meaningful budget cuts.
He felt that it would be hard work to get to a long-term,
balanced, sustainable budget even using the permanent funds
earnings.
9:20:03 AM
Senator Dunleavy shared that Alaska enjoyed a smaller
population and an economic boom in the mid-1980s.
9:20:22 AM
Senator Bishop stressed the importance of reigning in
deferred maintenance in order to cut capital budget
spending. He expressed distain for deferred maintenance as
a liability.
9:21:37 AM
Vice-Chair Micciche referred to a research paper from
Institute of Social and Economic Research (ISER), published
in 1992, which was written at the time of a $2.5 million
operating budget. He noted that the legislature had cut the
operating budget by 35 percent over the past 3 years. He
believed that the price of oil would recover in the future.
He thought that it was important to remain fiscally frugal
when crafting future budgets.
Commissioner Hoffbeck responded that the state needed to
adopt a rules based system for use of earnings.
9:23:39 AM
Vice-Chair Micciche referred to Page 2 of the ISER report,
which listed five checklist items for fiscal strategy: cut
spending, use permanent fund earnings, encourage economic
development, levy taxes, and conserve and invest windfalls.
9:24:12 AM
Senator Olson referred to Slide 7. He wondered whether the
unfunded liability from the early 2000s was reflected in
the current numbers.
Commissioner Hoffbeck responded that any money that had
been spent to cover deficits would appear as spending.
Senator Olson understood that the predicted liability was
not reflected in the presentation.
Commissioner Hoffbeck replied that the spending on the
liability was reflected in the presentation, and that long-
term liability payments had been modeled in the governor's
plan.
9:25:03 AM
Co-Chair MacKinnon noted that the state continued to retain
long-term pension liability of upwards of a billion
dollars, which contributed to the state's economic
volatility. She said that the governor's original proposal
included the use of pension obligation bonds to manage the
liability, and the Senate had been working to lower that
reoccurring operating cost.
Co-Chair MacKinnon welcomed Co-Chair Kelly to the table.
9:25:52 AM
Commissioner Hoffbeck presented Slide 8, "Why the Permanent
Fund?":
· Other pieces of the plan provide millions, the Fund
can sustainably contribute billions
· Placing petroleum revenues in the Permanent Fund is
the cleanest way to address oil price volatility
· There is no solution without Permanent Fund earnings
and adjusting the dividend
Commissioner Hoffbeck opined the challenge of impressing
upon the public the magnitude of a billion physical
dollars, and how difficult it was to achieve savings in the
billions.
9:26:58 AM
Commissioner Hoffbeck discussed Slide 9, "Why the Permanent
Fund?":
"Of all the fiscal options for closing the deficit,
only saving less of Permanent Fund earnings . . .
would have no short-run economic impacts."
Economic Impacts of Alaska Fiscal Options: Draft
Report
Gunnar Knapp, Mouhcine Guettabi, and Matthew Berman
Institute of Social and Economic Research (March
2016).
Commissioner Hoffbeck added that because of the sustainable
draw that anticipated high and low years of revenue; the
Permanent Fund Protection Act was the only solution that
could deal with current low price volatility without
breaking the rules based structure set up for spending.
9:27:58 AM
Commissioner Hoffbeck turned to Slide 10:
DELAY WILL . . .
· Reduce the sustainable draw
· Risks a downgrade of Alaska's credit rating
· Damage the economy
Commissioner Hoffbeck relayed that the uncertainty of how
the state would resolve the fiscal crisis was a component
considered by the private sector in investment strategies.
9:29:15 AM
Senator Dunleavy whether the state's economy would be
damages by the current fiscal climate.
Commissioner Hoffbeck did not think that there was any way
to avoid some damage to the economy, considering the
current level of oil prices and the impact of that on both
the private and public sectors.
9:29:39 AM
Commissioner Hoffbeck showed Slide 11, "Lower Sustainable
Draw."
Commissioner Hoffbeck hypothesized that if $1 billion were
left unresolved in FY16, the sustainable draw going forward
would be $100 million less. The $100 million went
throughout the life of the state's finance, which would
mean more cuts, or more revenues, in order to balance.
9:30:21 AM
Co-Chair MacKinnon requested an analysis on how the $100
million figure had been determined, the interest rate
assumed on the $1 billion and where it was located, was it
staying in the constitutional budget reserve or the
earnings reserve account. She felt that the figure was high
for an opportunity loss cost.
Commissioner Hoffbeck agreed to provide the information.
9:30:43 AM
Commissioner Hoffbeck moved to Slide 12, "Cost of a
Downgrade":
"The state sold $135 million of general obligation
bonds yesterday [03/09/16], its first sale in almost a
year. Tax-exempt securities maturing in August of 2035
sold at a top yield of 2.9 percent, about 0.35
percentage point higher than the benchmark securities
due in 20 years. That gap is four times wider than
what the state paid when it last sold debt in March of
2015."
-Bloomberg News
Commissioner Hoffbeck opined that the state had already
seen the costs of a downgrade.
9:31:20 AM
Commissioner Hoffbeck showed Slide 13, "Damage to Alaska's
Economy":
· Lower sustainable draw from financial assets
requires
o More taxes
o Less government spending (services and jobs)
· Degraded confidence and less private sector
investment
· Direct impacts on Alaskans
o Job Market
o Home Values
Commissioner Hoffbeck stressed that any decisions that the
legislature made would have long-term effects on the people
of Alaska.
9:32:09 AM
Co-Chair MacKinnon queried whether the committee was
interested having the Department of Labor and Workforce
Development (DOL) speak to the governor's veto of oil tax
credits in the FY 16 budget and how it affected
unemployment in the state. She expressed concern with the
information on the slide. She revealed that she had
suffered from real estate economic instability in the late
1980's.
Members nodded in the affirmative.
9:32:58 AM
Senator Bishop requested that Neal Fried, research and
analysis staff for DOL, represent the department before the
committee.
9:33:07 AM
Vice-Chair Micciche lamented the huge home value impacts on
municipalities that resulted from economic downturns. He
felt that municipalities were bearing increasing weight due
to the fiscal climate of the state.
Co-Chair MacKinnon wondered whether DOL had any data
detailing how Alaskans spent their permanent fund
dividends.
9:34:20 AM
Co-Chair MacKinnon wondered whether the committee was
interested in hearing from the Alaska Realtors Association
on the home value issue.
Co-Chair Kelly suggested the Chair of the Alaska Board of
Realtors.
Co-Chair MacKinnon believed that a conversation with a
state assessor could shed some light on the issue.
9:35:34 AM
Senator Dunleavy thought that a similar conversation should
occur concerning the depressed energy costs for the average
Alaskan.
Co-Chair MacKinnon thought that an economist could provide
insight on disposable income increasing for average
Alaskans as energy costs went down at a greater degree in
rural Alaska than urban areas. She said that rural Alaska
bought in bulk tanks and could be sustaining higher costs.
Senator Dunleavy referred to an older ISER study that could
be referenced on the matter.
9:36:33 AM
Senator Bishop thought the University of Alaska could
provide further economic research at no cost to the state.
Co-Chair MacKinnon clarified that she was not proposing any
studies, and was interested only in reaching out to
Alaskans who had information to share that might shed light
on Alaska's economic future.
9:37:04 AM
CRAIG RICHARDS, ATTORNEY GENERAL, DEPARTMENT OF LAW,
referred to Slide 15, "Government Spending and the
Economy":
· The Commodities Roller Coaster -
the International Monetary Fund studied
85 economies over 3 decades
· Government spending in commodity-based economies
tends to move up and down with commodity revenue
· Pro-cyclical government spending stunts economic
growth
· Stabilizing fiscal policy has the inverse effect,
increasing GDP growth by 0.3% annually
Mr. Richards explained that the state was not unique to
other states; Alaska suffers the problems of an
undiversified, commodity based economy.
9:39:08 AM
Mr. Richards turned to Slide 16, "Break-Even Oil Price":
· A widely used rule-of-thumb measure of the oil
price required to balance the government budget
in any given year
o Options for petroleum states to bring down
break-even oil prices are generally
Diversify revenues through other types of
taxation
o Use sovereign wealth assets
· Alaska: $109
Mr. Richards noted that the break-even oil price for the
nine other petroleum states were listed on the right hand
side of the slide; Alaska rested between Russia and Saudi
Arabia in terms of the need to have about $110 p/bbl oil in
order to balance the budget.
9:40:19 AM
Mr. Richards discussed Slide 17, "Oil: Break-Even Price and
Share of Revenue," which graphed the oil price required to
balance the budget on one axis, and oil's percentage share
of total government revenue on the other. He said that the
blue and yellow bubble son the slide depicted classes of
oil economies that had successfully diversified their
governmental revenues away from high commodity price
independence. He noted that the numbers were from 2013 and
represented a high commodity price environment. He stated
that currently the state had a high break-even oil price,
and the total share of governmental revenue relative to
other sources of revenue was highly dependent on oil. The
chart put Alaska up with Saudi Arabia and other Middle
Eastern oil economies that had not successfully
diversified. He noted that the blue bubble, which contained
Wyoming, Alberta, and Norway, had successfully been able to
become independent of commodity revenue by adopting broad
based taxation so that they were not totally dependent on
oil. He related that those economies had the advantage of
taxation options, which Alaska did not. He noted that the
yellow circle had economies more comparable to Alaska, and
those economies used sovereign wealth fund assets to create
a fiscal plan that allowed for the diversification of total
governmental revenues by using savings in a way that made
them less dependent year-to-year on financial assets.
9:42:40 AM
Vice-Chair Micciche queried why the economies in the yellow
bubble did not move to the blue bubble once revenues were
realized by the state.
Mr. Richards replied that the red arrow on the chart could
indicate a state moving to the bubble on the left. He said
that he did not know why the red arrow did not slope toward
the lower oil price required to balance the budget. He felt
that the slide was illustrative of the point that the state
could diversify its income stream by using financial
savings in a way that took some of the volatility out of
the year-to-year dependence on oil prices.
9:43:54 AM
Co-Chair MacKinnon referred to Slide 16. She felt that
presenters before the committee always chose best case
scenarios to represent their agenda.
Mr. Richards believed that the information that the
administration was putting forward was the best information
to offer in order to get to a solution.
Co-Chair MacKinnon referred to Slide 17. She contended that
the taxation in Norway was between 50 to 75 percent, and
their sovereign wealth fund did not contribute to the
people of Norway. She noted that Alberta and Wyoming also
taxed their residents. She wondered whether the states in
the yellow bubble taxed their people, or employed complete
sovereign wealth.
Mr. Richards responded that he was not in possession of
exact numbers, but thought that those represented in the
yellow bubble relied primarily on petroleum revenues and
sovereign wealth funds, and blue bubble indicated states
that had broad based taxation that differed from solely
financial savings. He noted that all three of the economies
in the blue bubble had permanent funds. He understood that
Norway did not spend its petroleum revenues, but deposited
them in an account approximated at 1 trillion, and used a 4
percent of market value approach.
Co-Chair MacKinnon recalled a conversation with a
consultant that had asserted that Alaska was in a better
wealth position than Norway.
Mr. Richards clarified that Alaska was displayed in the
graphic with a break-even oil price of $110 p/bbl, and was
not in an enviable position from the income statement side.
He said that Alaska had a high level of oil price
dependence and needed high oil prices in order to be in the
black. He relayed that the state was in the opposite
situation in term of total financial savings. Alaska had
$55 or $60 billion in unencumbered financial assets and a
$5 billion dollar budget; meaning that the state had 12
times financial savings than annual spending, which put the
state at the highest level of sovereign wealth savings, to
total governmental expenditure in the world. He stressed
that used intelligently, the state had the opportunity to
take an immense financial base and use it to bring down a
bad income statement.
9:47:52 AM
Co-Chair Kelly agreed with Mr. Richards regarding the goal
of getting off the "commodities rollercoaster". He spoke to
Keynesian economics and how they applied to the state's
budget. He shared that following those various theories
made him uncomfortable. He felt that taxation was not the
only way to diversify an economy, but was a way to
diversify government revenue. He believed that changes that
were more favorable to the private sector, and not
Keynesian economics, would be better for the state. He
contended that once the administration decided that the
goal was to take care of government, government spending
would increase. He felt that the administration's goal was
to continue to feed government spending.
9:50:59 AM
Mr. Richards observed that by discussing Keynesian
economics he had not intended to broaden economic policy.
He suggested that in times of down economies, if the
government had extra money to spend on capital budgets,
perhaps it would be better to spend more in order to
flatten out the economy. He agreed that there was a
distinction between growing the economy and growing
governmental revenue; however, the wat to get off the
commodity price roller coaster was to go for broad based
taxation, to use sovereign wealth assets, or a combination
of the two. He asserted that Alaska's ability to use
financial savings was greater than the ability to tax
residents.
9:52:01 AM
Co-Chair Kelly encouraged Mr. Richards and Commissioner
Hoffbeck to separate what the administration was attempting
to do using sovereign wealth, from the discussion on taxing
Alaskans.
Mr. Richards replied that he appreciated the advice.
9:52:19 AM
Senator Dunleavy spoke to Slide 17. He noted that without
government spending there would be no economy in Alaska. He
felt that a government that provided basic services,
separate from the economy, should be explored.
9:54:04 AM
Co-Chair MacKinnon considered a discussion on economic
structures in differing political regimes.
Senator Dunleavy pondered government support of the economy
and social dislocation.
9:54:45 AM
Mr. Richards observed that moving from the yellow bubble to
the blue bubble would require getting off the commodity
rollercoaster by diversifying the economy. He asserted that
in order to grow an economy that was not petroleum revenue
or governmental spending based, the state needed to provide
stability for economic growth in other sectors.
9:55:36 AM
Senator Dunleavy noted that the bill could solve the
state's revenue issue, but would not solve the issue of
economic diversification.
9:56:22 AM
Mr. Richards referred to the International Monetary Fund
paper on Slide 15. He explained that until the state could
control the fluctuation in the economy, caused by oil price
dependence, it was hard to diversify into other sectors. He
stated that the state could not diversify without first
stabilizing the economy.
9:57:00 AM
Vice-Chair Micciche thought that the current fiscal crisis
left Alaska exposed; oil constituted 90 percent of the
state's revenue. He said that the states in the blue
bubbles had additional revenue streams after oil monies. He
felt that of the governments in the country that were
responsibly operated, Alaska was the international outlier.
He said that he, "did not want to be Norway" but admitted
that something needed to be done to address the current
fiscal situation.
9:58:40 AM
Senator Bishop pointed out that the cost for Saudi Arabia
to increase the flow of crude oil was $12 to $14 p/bbl. He
thought that, due to commodity prices, Norway would make a
draw for the first time on their sovereign wealth fund.
Mr. Richards informed the committee that an expert would be
brought before the committee to discuss the nuances of the
different countries on the slide.
9:59:46 AM
Mr. Richards looked at Slide 19, "Rule-Based Framework." He
stated that there was a correlation between unrestricted
general fund spending and prior year petroleum collations.
He added that the state had a habit of making spending
projections based on prior year total revenues. He
furthered that the permanent fund operated within a rules
based framework which allowed for dividends to be paid out
of the earnings reserve, inflation proofing back to the
corpus, and saving the remainder. He shared that the rules
based framework had never been violated. He admitted that
the state did not have incredible discipline when it came
to saving money from year-to-year in unrestricted
budgeting, but that the legislature had displayed
unrelenting discipline regarding the fund. He observed that
the reason was not solely because the permanent fund was
Constitutionalized; the rules-based frame work was based in
statute and could have been violated by a vote of the
majority, yet the custom in Alaska had been not to do so
for a variety of reasons. He said that the administration
hoped to duplicate the way in which the rules-based
framework worked in a manner that met the current fiscal
reality in a logical way.
10:02:22 AM
Co-Chair MacKinnon queried whether the double dividend of
2008 had been inside the rules-based framework.
Mr. Richards understood that the second dividend of 2008
had come out of the general fund.
Co-Chair MacKinnon pointed out that a substantial amount of
money had been sent out to Alaskans.
Mr. Richards replied yes, and without altering the rules-
based framework of the permanent fund.
Co-Chair MacKinnon whether the legislature had saved and
paid back all CBR withdrawals since 2007.
Mr. Richards replied in the affirmative.
Co-Chair MacKinnon reiterated that the legislature had
repaid all funds that had been previously borrowed from the
CBR.
Mr. Richards replied, again, in the affirmative.
10:03:33 AM
Senator Olson asked whether or states with a similar
sovereign wealth fund gave out a dividend to their
residence.
Mr. Richards believed that Wyoming used its earnings for
their broad based education system, Alabama used their
earnings for its road system, and Texas used their
permanent fund earnings for their road system.
10:04:30 AM
Senator Olson asserted that much of the public had advised
legislators to leave the permanent fund alone while seeking
solutions to the fiscal problems of the state.
Commissioner Hoffbeck believed that there had been a shift
in the public's perception of using the permanent fund
earnings. He said that the administration had worked to
education the public on what would be the proper way to use
the funds earnings.
10:05:58 AM
Senator Dunleavy reported that Finland was contemplating
giving each of its citizens $10,000, in an effort to spur
private sector activity.
10:06:37 AM
Senator Olson said that there had been talks in the past of
giving every Alaskan resident a $25,000 one-time dividend.
Mr. Richards looked at Slide 20, "APFPA," which offered a
breakdown of how the act would work:
· Volatile petroleum revenues to the Permanent Fund
· $3.3 billion draw to the General Fund
· Dividends
50% royalties
Mr. Richards said that the bill would place oil production
taxes and royalties in the permanent fund, draw out of the
permanent fund the fixed amount of $3.3 billion to be
deposited into the general fund yearly, and it would change
the dividend pay-out calculation to equal 50 percent of
royalties.
Co-Chair MacKinnon asked whether the dividend would be
drawn out of the corpus of the fund, or the earnings
reserve account (ERA).
Mr. Richards stated that, constitutionally, 25 percent of
royalties went to the corpus of the fund, all statutory net
income traveled from the corpus and into the earnings
reserve. The corpus of the fund was not constitutionally
available for expenditure, but the earnings reserve was
available by a majority vote. He concluded that, barring a
constitutional amendment, all plans to use permanent fund
earnings, or other permanent fund assets, had to be
expenditures out of the ERA - including the payment of
dividends.
10:09:05 AM
Co-Chair MacKinnon clarified that the 25 percent
constitutionally required went into the corpus, and the
remaining 74.5 percent went into the ERA to be managed
similarly.
Mr. Richards replied in the affirmative.
Co-Chair MacKinnon noted that the remaining .5 percent was
placed in the Mental Health Trust fund.
Mr. Richards answered in the affirmative.
Co-Chair MacKinnon added that the deposit was a federal
requirement.
Mr. Richards understood that putting the .5 percent into
the Mental Health Trust fund had been a result of
litigation. He could not recall if it had been on the state
or federal level.
Co-Chair MacKinnon asked Ms. Mills, in the gallery, whether
the case had been on the federal level.
Ms. Mills replied yes.
10:10:11 AM
Senator Bishop asked whether the plan changed in any way
the investment strategy of the permanent fund board.
Mr. Richards answered in the negative. He added that if the
state drew from the ERA on an annual basis under any of the
proposed plans, the board would need to manage for
additional liquidity.
10:11:12 AM
Senator Bishop theorized that the $3.3 billion draw might
not be available in certain future years. He suggested that
the budget could be short funded in the future, regardless
of which plan is implemented.
Mr. Richards explained that the plan would take the
constitutionally required 25 percent of the royalties and
placed them into the corpus. Then, approximately 75 percent
of the royalties would be deposited into the ERA, as well
as all production taxes. The other cash flowing into the
ERA would be considered statutory net income, which creates
an income stream into the ERA. Three things would come from
the ERA: 50 percent of royalties to pay dividends, the $3.3
billion draw for the General Fund, and when the earnings
reserve reached a balance of 4 times the annual payout of
$3.3 billion any extra would be placed into the corpus and
would be constitutionally protected.
Mr. Richards addressed the assertion that the plan ran a
substantial risk of failure. He said that the issue would
be whether the ERA had a sufficient enough balance to
instill confidence even during bad market years. He relayed
that the small chance that the ERA would not be available
for the $3.3 billion draw would exist under any plan; the
current plan had been designed to reduce the chance of
shortfall to a very high degree. He thought that the Callen
and Associates estimations were high, and shared that the
administration had adjusted for chance by establishing the
target of amassing 4 times the balance of the annual draw
into the ERA, and by creating the periodic review. The
review entailed that every four years the balance of the
ERA would be assessed in order to decide whether the system
needed adjustment. He relayed that four years had been
chosen because every four years there would be four times
the amount of payment in the ERA. He said that the plan was
made more robust by the proposal of $3 billion from the CBR
into the ERA. He pointed out to the committee that the $3
billion would not be required in order for the plan to
work, but offered a higher level of confidence that the ERA
would be large enough to accommodate bad market years.
10:16:16 AM
Co-Chair MacKinnon stated that she would be meeting with
the Executive Director of the permanent fund board. She
summarized that the asset allocation would remain the same
with the board managing the fund.
Mr. Richards could not speak to the accuracy of the
summarization. He said that he had requested that Angela
Rodell, Executive Director, Alaska Permanent Fund
Corporation brief the trustees on the issue. He was not
aware of whether or not there was an expectation that the
asset allocation would change if additional petroleum
revues were placed in the fund.
10:16:58 AM
Co-Chair Kelly understood that the 25-30 percent failure
rate had been calculated using the assumption of a higher
level return from the permanent fund and an old oil revenue
forecast.
Mr. Richards replied in the affirmative. He added that the
new spring 2016 forecast put out by the department used a
new petroleum projection. He revealed that for the plan
under the bill the forecasted revenues did not particularly
matter. He related that the permanent fund analysis may
have down stated return assumptions. He shared that a
future meeting with the board would reveal more on the
matter.
10:17:51 AM
Co-Chair Kelly thought that the failure rate might increase
as the to-date numbers changed.
Mr. Richards replied that if assumed petroleum revenues and
return assumptions were lowered, the probability of failure
would increase.
10:18:08 AM
Co-Chair MacKinnon spoke to the assumptions used in the
crafting of the plan. She wondered whether the actuaries
had assumed for lost opportunity cost due to the changes in
the per-year cash draw and the need for higher liquidity on
an annual basis.
Mr. Richards relayed that the administration had examined
the issue and had concluded that it was irrelevant. He
shared that the administration believed that it could "go
long" with other financial assets that were currently held
"short". He thought that there would be some modeling
affect, but that the remaining balance of the CBR was
short, and not long, which suggested that the total amounts
would be similar.
10:18:56 AM
Co-Chair MacKinnon referred to a previous slide which had
indicated $100 million on $1 billion worth of opportunity
cost lost. She said that if a $3.3 billion draw were to be
taken annually, there would be between $0 and $100 million
worth of opportunity cost lost on assets sitting in more
fixed reserves.
Mr. Richards responded that because of the way the cash
flow was structured he could not estimate the magnitude of
opportunity cost lost.
10:19:44 AM
Mr. Richards showed Slide 21, "Defining 'Sustainable'":
· Protect the Corpus
· Earnings Reserve Durability
· Inflation Proofing
o Maintain the real value of the Permanent Fund
o Transfers to the Corpus
Mr. Richards believed that it was important to have a
meaningful definition for "sustainable" when determining at
what level to draw from the fund. He relayed that from the
administration's point of view in order to equitably
preserve the state's financial assets over time, the amount
drawn down should not reduce the inflation adjusted value
of the fund, and examining the durability of the ERA to
assure for sustainability.
10:20:49 AM
Mr. Richards turned to Slide 22, "How to Handle the Draw":
· Status quo framework
o Sustainable draw §ELOOLRQ
o Funds to the general fund = $2.4 billion -
dividend ($1.4 billion in FY16)
· APFPA framework
o Sustainable draw = $3.3 billion or 6% POMV
o Separate cash flow allocated to the dividend
POMV
· Draw self-adjusts
o Lower chance of depletion
o Less fund growth potential
· Year-to-year budget volatility*
Fixed
· Draw does not self-adjust
o Greater chance of depletion
o Greater fund growth potential
· Stable Budget
*Volatility may be reduced, but not eliminated, with
use of smoothing rule such as 5- year averaging
Mr. Richards explained that the administration had
determined that placing petroleum revenues in the forms of
royalty and production taxes into the permanent fund, as
proposed by SB 128, the sustainable draw would be $3.3
billion; alternatively; a 6 percent of market value draw
(POMV). He relayed that the stability of a fixed draw to
the general fund made more sense than a POMV draw. He said
that a draw a 6 POMV could be done, and was mathematically
equal to the $3.3 billion draw, it was a matter of
determining which had the higher level of variability. The
administration had determined that the volatility should be
kept in the permanent fund and not be allowed to flow
through to the governmental share of revenues. He added
that both POMV and a fixed draw were plausible plans with
fairly equal risks and benefits.
10:23:14 AM
Vice-Chair Micciche stated that the modeling on the draw
suggested an assumption of a commodity price, and therefore
an eventual production tax improvement. He probed the
administration's modeling on the expectations for
production taxes.
Mr. Richards stated that the distinction between the way
that DOR did oil price modeling in the Permanent Fund
Protection Act, and the way it was presented in the Revenue
Forecast was that DOR used probabilistic modeling, which
projected a large range of values and assigned a percentage
chance across those values of possible oil prices. He
relayed that probabilistic modeling was important when
looking at petroleum revenues because of the progressive
nature of the tax.
10:25:03 AM
Co-Chair MacKinnon queried the purpose of the restructuring
effort. She felt that the projected draw would support the
current status quo funding for state government, rather
than putting the draw into the general fund in order to pay
the state's bills.
Mr. Richards replied that he would speak to the issue
further in the presentation.
Co-Chair MacKinnon thought a 6 percent rate of return was
ambitious for a sovereign wealth model; other POMV's across
the nation, and globally, were set at a rate of 4.25
percent.
Mr. Richards stated that the 6 percent was higher than the
more traditional approach was due to the fact that the
state would place petroleum revenue into the permanent
fund. The incoming cash flows would be greater than what
was earned solely on financial assets, which would allow
for a larger take of the total value.
10:26:52 AM
Senator Hoffman wondered whether the funds could be kept in
the ERA until the success of the plan was proven, and then
make the percentage change, with caution, in the future.
Mr. Richards did not think time would make a great deal of
difference. He spoke to the issue of growing the assets
before spending them in the earnings reserve, he shared
that the system had been designed to meet current needs, at
a sustainable level.
Senator Hoffman expressed concern that if the state were to
be successful and have additional funds that were targeted
to go back into the corpus, those funds could never be
taken out again. He asked how stable the dividend would be
under the legislation.
Mr. Richards stated that under the bill, the dividend would
be 50 percent of the royalties. He said that the dividend
would not be stable in the sense that it would be subjected
to oil price volatility and changes in production
forecasting. He clarified that the way in which the
dividend was drawn was interchangeable between different
restructuring plans, the governor's plan only changes the
sustainable draw amount. Whatever dividend formulation the
legislature chose, the draw would be adjusted accordingly.
10:29:57 AM
Vice-Chair Micciche maintained his request for information
concerning the assumptions and failure rate.
Mr. Richards stated that the information was all already
public. He stressed that, although the department had
changed its deterministic price forecast, did not change
its probabilistic modeling or assumption. He offered to
write a letter that explained the matter to the senator.
10:30:40 AM
Mr. Richards turned to Slide 23, "How to Handle the Draw."
The slide depicted a hypothetical world in 2002, when the
state had adopted POMV, the yellow represented what the
permanent fund would have contributed after dividends. He
said that the slide demonstrated that moving to a
traditional POMV did not address the state's economic
volatility; it layered the earnings of the state's
financial assets onto already volatile petroleum revenues.
He warned that in high years, that could compound pro-
cyclical spending by putting unneeded money into the
general fund.
10:31:55 AM
Mr. Richards discussed Slide 24, "How to Handle
Volatility":
STATUTORY NET INCOME (SNI) VOLATILITY
· Option 1:
o SNI placed in earnings reserve
o Formulaic draw (e.g., fixed draw or POMV)
· Option 2: constitutional amendment allowing pure
POMV
PETROLEUM REVENUE VOLATILITY
· Option 1:
o Royalties and production taxes placed in
earnings reserve
o Formulaic draw (e.g., fixed draw or POMV)
· Option 2:
o Revenue limit
o Reduce POMV draw as petroleum revenues in
general fund go up
· Option 3:
o Spending or appropriation limit not linked
to earnings
o Difficult to have a dependable rule
10:32:57 AM
Co-Chair MacKinnon about the hope of the CBR being
reimbursed.
Mr. Richards replied that under the bill repayment to the
CBR would need to come from revenues other than petroleum
production taxes, royalties, and permanent fund earnings;
those three earnings would not be used to pay back the CBR.
The CBR would be paid back through other forms of taxation,
royalty settlements, and other types of future income.
10:34:10 AM
Senator Bishop commented that the legislature would not be
limited in creating a payment plan back to the CBR.
Co-Chair MacKinnon agreed, but was bothered by the
statement that taxes would be collected in order to pay
back the money borrowed from the CBR.
Mr. Richards alleged that the plan would treat the two
major sources of volatile petroleum revenue the same as
earnings from the permanent fund. He directed the
committee's attention to Option 1 on the slide, stating
that the option treated the volatility of the two sources
of petroleum revenues the same way that earnings were
treated - by housing the income in the earnings reserve,
and then drawing them down based on POMV or a fixed draw.
10:36:40 AM
Mr. Richards turned to Slide 26, "Calculating the Draw -
Annuity Payment to the General Fund":
Starting Balance = $55 billion ($45B in corpus;
$7B in earnings reserve account; $3B from CBR)
+ Inflows =
Investment income
100% production taxes
100% royalties
- Outflows =
Expenses
Dividend
Draw (inflation increase delayed until 2020)
= End-of-Year Balance
… $3.3 billion annuity from financial and
petroleum wealth
(2040 Balance = 2016 Balance + Inflation)
10:39:07 AM
Senator Hoffman asked whether the $3 billion draw from the
CBR would require a three-quarter vote.
Mr. Richards understood that the vote would still be
required. He shared that the plan did not need the $3
billion draw in order to work, but that the draw increased
the success of the plan.
10:39:35 AM
Co-Chair Kelly considered the $3.3 billion as a mechanism
to ensure the permanent fund retained its value.
Mr. Richards concurred. He furthered that a larger draw
could result in an estimated value of the fund that would
not grow with inflation.
Co-Chair MacKinnon interjected that there was greater
durability in the ERA if an addition $3 billion were to be
added, because then there would be 4X the cash call.
Mr. Richards replied in the affirmative.
10:40:25 AM
Senator Bishop asked whether the failure rate increased
without the $3 billion deposit into the ERA.
Mr. Richards replied that he could provide the information
at a later date.
10:41:09 AM
Vice-Chair Micciche wondered whether there was a plan for
"smoothing" on the dividend on a five-year running average.
10:41:58 AM
Commissioner Hoffbeck presented Slide 28, "How to Handle
the Dividend." He emphasized that the dividend was
volatile, and was a formula based calculation that varied
from year to year.
10:42:27 AM
Commissioner Hoffbeck turned to Slide 29, "How to Handle
the Dividend":
· Earnings Dividend (current formula): half of
statutory net income (SNI)
· Royalties Dividend: connects Alaskans to the
economy
· POMV Dividend: based on Fund market value, not
SNI
· CBR Dividend: based on CBR balance; rewards
Alaskans for Legislature maximizing stabilization
account
· $1,000 Flat: ~ $650 million, reduces the
sustainable draw
· Mixed Formula: combination of different ideas
10:43:12 AM
Commissioner Hoffbeck discussed Slide 30, "How to Handle
the Dividend":
· Dividend formula should connect Alaskans to the
economy and the fund
· Certain draw and dividend combinations do not
work well
o POMV draw & earnings dividend
o Volatile dividend formula (i.e. royalty
dividend) and floor
· Dividend formula tied to the balance of
stabilization funds (i.e., CBR) runs risk of
politicizing rule-based dividend payout formula
10:43:42 AM
BILL MILKS, ASSISTANT ATTORNEY GENERAL, DEPARTMENT OF LAW,
discussed Slide 32, "Alaska Permanent Fund Protection Act":
Section 1: Revenue to the Corpus
Section 2: Defines "target balance"
Section 3: Conforming Amendment
Section 4: ERA transfer to Dividend Fund
Section 5: ERA transfer to Corpus
Section 6: Revenue to the ERA, Draw, and Periodic
Review
Section 7: Conforming Amendment
Section 8: Conforming Amendment
Section 9: $1,000/person dividend in 2016
Section 10: Effective July 1, 2016
Mr. Milks discussed the sectional analysis (copy on file):
Section 1 - Revenues to the Corpus
Section 1 amends AS 37.13.010(a) to increase the
petroleum revenues directed to the corpus of the
permanent fund, subject to a redirection
mechanism that ensures the earnings reserve
account is not degraded.
o Production Taxes: 100% of production taxes
are directed to the corpus
ƒ Currently, these funds go to the
general fund
ƒ Requires an appropriation
o Mineral Royalties: 49.5% of all mineral
royalties are directed to the corpus
ƒ Constitutionally mandated 25% (no
change)
ƒ An additional 24.5% (an increase from
5%)
o Redirection Mechanism: if needed to maintain
the target balance (see Sections 2 and 6),
some petroleum revenue may be redirected to
the earnings reserve account
o Removes distinction between old and new
leases
Section 2 - Target Balance of the Earnings Reserve
Account
Section 2 adds subsection (d) to AS 37.13.010,
which cross-references AS 37.13.145(l) (see
Section 6), setting the target balance at equal
to four times the prior year's sustainable draw.
Section 3 - Conforming Amendment
Section 3 is a conforming amendment to AS
37.13.140 that removes the calculation of "income
available for distribution" because (1) the term
relates to the current dividend formula, which
would change (see Section 4), and (2) other
revenues, including production taxes and
royalties, may also be available in the earnings
reserve account.
10:46:38 AM
Mr. Milks addressed Section 4:
Section 4 - Transfers from the Earnings Reserve
Account to the Dividend Fund
Section 4 amends AS 37.13.145(b) to change the
calculation of the annual dividend.
· Changes the amount transferred from earnings
reserve account to the dividend fund to 50%
of the prior year royalties instead of
approximately 50% of realized investment
earnings
· Changes timing of the transfer from the end
of the fiscal year to the beginning
10:47:17 AM
Mr. Milks addressed Section 5:
Section 5 - Transfers from the Earnings Reserve
Account to the Corpus
Section 5 amends AS 37.13.145(c) to change the
timing and amount of transfers from the earnings
reserve account to the corpus.
· Changes amount transferred to the corpus
from the amount necessary to inflation proof
the corpus to funds in earnings reserve
account exceeding the "target balance"
· Changes timing of the transfer from every
year to when excess funds are available
· Flexible inflation proofing and a
presumption of savings
o Over time, these transfers inflation
proof the corpus
o Transferred funds may exceed the amount
needed for inflation proofing
o The flexibility in timing improves the
durability of the earnings reserve
account and protects the corpus
10:47:47 AM
Mr. Milks discussed Section 6:
Section 6 - Revenues to the Earnings Reserve Account
and the Sustainable Draw to the General Fund
Section 6 adds subsections (e) to (l) to AS
37.13.145 to direct some petroleum revenues to
the earnings reserve account and establish the
endowment transfer to the general fund.
· Redirection Mechanism: Subsections (e) and (f)
mirror the redirection provisions in Section 1.
Specifically, if needed to maintain the target
balance, up to 100% of production taxes and 24.5%
of royalties that are otherwise deposited in the
corpus may be redirected to the earnings reserve
account.
o Durability of the earnings reserve account:
making these petroleum revenues available to
the earnings reserve account helps ensure it
is not depleted if there are several
consecutive years of low petroleum revenue
and low investment income
o Protects the corpus: depleting the earnings
reserve account would put the corpus at risk
as the state searches for additional funds
to pay for government
o Savings: establishes a presumption of saving
excess revenue in the corpus when possible
· Dividend Royalties: Subsection (g) provides that
funds for the dividend (50% of royalties) gather
in the earnings reserve account until they are
transferred to the dividend fund under Section 4.
o Retains the connection between the dividend
and the permanent fund.
o Helps with cash flow, particularly in first
few years.
o Establishes the cash flow pathways in the
first year and minimizes departures from the
permanent framework.
· Sustainable Draw: Subsections (h) and (i) provide
for the annual endowment transfer from the
earnings reserve account to the general fund.
o $3.3 billion fixed-draw
o Maximum amount
o Adjusted for inflation beginning in FY 2020
o Flexible transfer timing allows the Treasury
and the Alaska Permanent Fund Corporation to
work out a practical and efficient system
based on cash flow needs and investment
practices
· Appropriation
o Framework relies on legislature partnering
with the executive
o The Alaska legislature has a long history of
following a rule-based policy for the
earnings reserve account
· Periodic Review: Subsections (j) and (k) provide
for a periodic sufficiency of assets review and
adjustments to the draw amount.
o The Commissioner of Revenue, in consultation
with the Alaska Permanent Fund Corporation,
conducts a review of the state's financial
assets and forecasts and may recommend
adjusting the draw amount
o Scheduled: 2017, 2020, then every 4 years
o Formulaic: the periodic review uses the same
approach and variables used to calculate the
initial draw
o Protects the permanent fund: the periodic
review ensures that, in light of experience,
Alaska remains on a sustainable fiscal
course
o Collaborative: the review is provided to the
legislature
o Transparent: all supporting material - data,
modeling, etc. - must be made available to
the public in its native file format (except
for confidential taxpayer information which
may be provided in aggregated form)
· Subsection (l) defines "sustainable draw amount"
and "target balance."
10:50:01 AM
Co-Chair MacKinnon queried the reasoning behind choosing 4
years, rather than 3.
Commissioner Hoffbeck replied that the idea had been that
the review would fall in the middle of each gubernatorial
term.
10:51:43 AM
Mr. Milks continued to Sections 7 through 10:
Section 7 - Conforming Amendment
Section 7 is a conforming amendment to AS
37.13.300(c) isolating income of the mental
health trust fund from net income available for
transfer to the general fund.
Section 8 - Conforming Amendment
Section 8 is a conforming amendment to AS
43.55.080 directing production taxes to the
permanent fund.
Section 9 - $1,000 Dividends in 2016
Section 9 amends uncodified law to specify that
2016 dividend checks will be $1,000 per person.
This provision eases the transition to the new
dividend formula.
Section 10 - July 1, 2016 effective date
10:52:15 AM
Mr. Milks summarized that for a very important issue, the
bill was relatively straightforward.
10:52:39 AM
Mr. Richards encouraged the committee to examine Slide 33,
"Rule-Based Fiscal Policy":
· Savings Rule
o Permanent Fund SNI to earnings reserve
o 25% of mineral royalties to corpus
o 24.5% of royalties and 100% production taxes
to earnings reserve
· Growth Rule
o Assets grow with inflation
o Opportunities for additional growth assigned
to the corpus and dividend
· Protection Rule
o Constitutional protection of the corpus
o Transfers funds in excess of earnings
reserve target balance to the corpus
o Earnings reserve durability tested
· Spending Rule
o Draw: fixed $3.3 billion with periodic
review
o Dividend: 50% of annual mineral royalties to
Alaskans
· Volatility Rule
o Permanent Fund: SNI, 49.5% royalties 100%
production tax volatility in the Permanent
Fund
o Dividend: 50% royalty volatility in dividend
o General Fund: No SNI, royalty or production
tax volatility in general fund
Commissioner Hoffbeck reiterated that modeling of the plan
had been successful.
SB 128 was HEARD and HELD in committee for further
consideration.
10:53:47 AM
Co-Chair MacKinnon discussed housekeeping.
10:55:30 AM
RECESSED
1:05:06 PM
RECONVENED
Co-Chair MacKinnon discussed housekeeping.