Legislature(2003 - 2004)
03/29/2004 09:10 AM House FIN
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* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
HOUSE FINANCE COMMITTEE
March 29, 2004
9:10 A.M.
TAPE HFC 04 69, Side A
TAPE HFC 04 - 69, Side B
CALL TO ORDER
Co-Chair Williams called the House Finance Committee
meeting to order at 9:10 A.M.
MEMBERS PRESENT
Representative John Harris, Co-Chair
Representative Bill Williams, Co-Chair
Representative Kevin Meyer, Vice-Chair
Representative Mike Chenault
Representative Hugh Fate
Representative Richard Foster
Representative Mike Hawker
Representative Reggie Joule
Representative Carl Moses
Representative Bill Stoltze
MEMBERS ABSENT
Representative Eric Croft
ALSO PRESENT
Senator Gene Therriault; Bob Bartholomew, Chief Operating
Officer, Alaska Permanent Fund Corporation, Department of
Revenue; Cheryl Frasca, Director, Division of Management &
Budget, Office of the Governor; Joe Balash, Staff, Senator
Gene Therriault
PRESENT VIA TELECONFERENCE
None
SUMMARY
HB 298 An Act relating to the distribution of
appropriations from the Alaska permanent fund
under art. IX, sec. 15(b), Constitution of the
State of Alaska, and making conforming
amendments; and providing for an effective date.
HB 298 was SCHEDULED but not HEARD.
HJR 9 Proposing amendments to the Constitution of the
State of Alaska relating to an appropriation
limit and a spending limit.
HJR 9 was SCHEDULED but not HEARD.
HJR 26 Proposing amendments to the Constitution of the
State of Alaska relating to and limiting
appropriations from and inflation proofing the
Alaska permanent fund by establishing a percent
of market value spending limit.
HJR 26 was HEARD and HELD in Committee.
HOUSE JOINT RESOLUTION NO. 26
Proposing amendments to the Constitution of the State
of Alaska relating to and limiting appropriations from
and inflation proofing the Alaska permanent fund by
establishing a percent of market value spending limit.
Co-Chair Harris MOVED to ADOPT Amendment #3, #23-LS1006\V,
Cook, 3/22/04. (Copy on File). Co-Chair Williams
OBJECTED.
SENATOR GENE THERRIAULT spoke to Amendment #3. He
addressed concerns voiced by the public and members of the
Legislature regarding possible changes to the Permanent
Fund and the methodology used to determine that fund. The
first issue is one of protecting the principal of the fund.
When describing the Permanent Fund, it should be understood
that the money of the principal cannot be touched no matter
how much it is needed and the only way in which that could
change is through a vote by the people of Alaska. He
commented that the thought of moving toward a pure Percent
of Market Value (POMV) methodology would lift the bars that
protect the principal.
Senator Therriault indicated that Amendment #3 preserves
the idea of separate principal. There would remain the
protected principal of the Permanent Fund and would create
a sub account within the Earnings Reserve Account. The two
accounts would then be managed together except for the
allowable 5% draw. That amount could only be drawn out of
Earnings Reserve Account. If the allowed draw is only 5%,
there could be no access to the entire $4.5 billion
dollars.
Senator Therriault mentioned that there are a number of
ideas floating around about how to manage it. The Trustees
suggested a statutory fund that would protect the principal
if the State moved into a series of down market years. He
doubted that the public would understood how that worked
and thought that the idea of the Percent of Market Value
would turn out to be an "easy criticism" for them. Senator
Therriault pointed out that the public wants to protect and
guarantee the dividend. He voiced support for making the
dividend multi generational and was resistant to a one-time
disbursement as proposed by Senator Mackie during a past
legislature.
Senator Therriault stressed that there should be a long-
term dividend acknowledged in the Constitution. The
language should indicate that from the 5% draw and out of
the earnings reserve, the money can be used for two things:
• Continuation of the dividend; and
• Use of the remaining funds for public education.
Senator Therriault noted that Co-Chair Harris had added
language to cover the costs of the fund's management. He
thought that would be a policy call. If there is access to
use of some of the earnings, the public will want to know
what those earning are being used for rather than assuming
purposes of general government. He pointed out that
everyone can think of something that they "loathe to hate".
The constitutional mandate that enjoys widespread support
is public education. That is the recommendation set forth
by Amendment #3 to address what the earnings are used for.
The term "public education" is broad and could cover K
University, K 12, or K 12 operations and capital. The
language could be left broad and/or the numbers could be
flushed out or specific to the intent.
Senator Therriault maintained that the language of the
amendment addresses concerns indicated by the general
publics who will understand and appreciate a protected
principal. Currently, there is no constitutional
protection for the dividend and they want to know what the
earnings will be used for. That creates a balance for
constitutionally enshrining the dividend and preserving
latitude for future legislatures to establish how much can
be steered into dividend programs.
Senator Therriault summarized that if the amendment
language is adopted, it would provide an indication of what
the protected principal can be and the growth would be
limited to oil rents and royalties as they get deposited
into the principal. All the Permanent Fund earnings would
be placed into the Earnings Reserve Sub Account. The only
growth would be the amount deposited into the principal
from rent and royalties, which could easily be fixed by
making an allowance to periodically adjust the principal
up. He referenced Page 2 of the amendment, identifying
appropriations from the Earnings Reserve Account. That
language could be modified to state: "Except for periodic
transfers to the principal appropriations". The language
could specifically make a constitutional allowance for
periodic moving from the Earnings Reserve Account to the
protected principal by the Legislature.
Co-Chair Harris commented that there was nothing in the
proposed language that would prohibit the Legislature from
making an appropriation from the Earnings Reserve Account
to the principal protected by the Constitution. Senator
Therriault responded that is a question, as it would be
limited to only the money that comes off the overall
account and amounting to the 5%. It specifically has been
identified that the 5% can only be taken from the Earnings
Reserve Account. Appropriations from the Earnings Reserve
Account may be made only for certain purposes. The
Legislature has not provided them the latitude to make
appropriations over to the principal, however, the language
could easily be modified to specifically address that.
Co-Chair Harris recommended that a sub-floor could be added
to indicate that appropriations move back to the principal.
Senator Therriault suggested that by adding #4, there is
some question whether an appropriation or principal could
come only out of the 5% drawn. He did not think they would
want to do that. At this time, Legislative Legal is
working on an amendment to modify that language so that a
transfer from the Earnings Reserve Account could be made
above and beyond the 5%. He believed that would be easy to
accomplish and then they would need to address policy
questions regarding the veto power of a transfer.
Co-Chair Williams reminded Senator Therriault how difficult
it is to get a super majority. Senator Therriault
acknowledged that it can be difficult but if the 5% only
comes out of the Earnings Reserve Sub Account, it is
important to make sure that a healthy balance remains in
that account in case there is a down stock market, there
would still be sufficient funds. The Legislature could
feel pressure to make transfers to the principal; if the
Governor believes that too much has been transferred
without having a cushion, there might be a veto, which is a
part of the check and balance system.
Representative Fate voiced concern about using the
Permanent Fund for "rainy day" purposes. He warned
consideration for the replenishment of the Constitutional
Budget Reserve (CBR). He asked Senator Therriault how he
proposed to address these concerns if the above-mentioned
items tied up the Earnings Reserve Account. Representative
Fate believed this could exacerbate the problem over the
years.
Senator Therriault responded that the issue of the CBR
repayment would be separate from the proposed
consideration. However, if covering the major costs for
public education was taken out of the Earnings Reserve
Account, then general fund dollars would not be spent.
There could be a possibility of a combination using
earnings, taxes and/or other revenue generating mechanisms
providing general fund dollars at the end of the fiscal
year and swept back into the CBR.
Representative Fate realized that those are expectations
and that he hoped that they would happen, however, present
and past experience indicate they have not yet come. He
suggested that the legislation will exacerbate the problems
and that the corpus expands and future problems will
continue. The worst-case scenario is "worrisome".
Vice Chair Meyer appreciated that the Percent of Market
Value concept automatically places funds into the principal
and asked how it would work under Amendment #3. Senator
Therriault explained that it would work in the same manner.
The protective principal and the Earnings Reserve Account
would be managed together. If there were a down market
without sufficient earnings, then a 5% draw would be taken,
without money drawn from the protected principal. The
intent is to have the entire fund managed, while
maintaining the fund and the 3% and then, the Earnings
Reserve Account would continue to grow. It would be good
to have flexibility to move some funds to the corpus while
automatic inflation proofing keeps happening. He
concluded that a 3% would be maintained so that inflation
proofing would be automatic.
Vice Chair Meyer understood that in the Percent of Market
Value concept as presented statewide. In the years when
the return is only 3%, it is highlighted that the payout
would continue to be at the 5% level. He hoped it could
reach 8%. Vice Chair Meyer asked if that would be enough
protection for the principal. He thought that the
amendment would provide a "new and different twist" for the
voter's comprehension.
Senator Therriault pointed out that in the pure POMV
concept, during a protracted down stock market, there could
be erosion of the principal. There does not need to be
erosion because the full 5% does not have to be taken. He
emphasized that the Legislature would be allowed to take up
to 5% and that the "suspicious public" might criticize that
action. The Legislature cannot assure them that the
erosion is not going to happen. If the language of the
amendment is adopted, it guarantees a protected principal,
noting that the Percent of Market Value methodology is
still workable but the State needs create a system in which
they can weather any down markets. Given Amendment #3, the
general public is assured that there will continue to be a
protected principal.
Representative Hawker pointed out that there are two
distinct issues being considered through the amendment:
• Consideration of the pure Percent of Market Value,
and
• Section #2, involving a dedication of what the
earnings might be used for.
Representative Hawker indicated that he would restrict his
thoughts to the percent of market value discussion. He
inquired if Senator Therriault had mentioned that the
income would be accounted for in the Earnings Reserve
Account rather than in the principal account. Senator
Therriault understood from working with Legislative Legal
that once the revenue is realized, it would then be
accounted for in the Earnings Reserve Sub Account.
Representative Hawker was confused if that meant only the
realized earnings and not those that result from increased
valuation. Senator Therriault referenced existing language
on Page 1, Lines 12 & 13, "All income from the Permanent
Fund shall be deposited into the Earnings Reserve Account."
He believed that should define all income.
Representative Hawker pointed out that section indicates
that all income in the fund shall be deposited into the
Earnings Reserve Account as soon as it is received. The
intent is that it must be the realized earnings as opposed
to valuation changes. If that is the intention, then it is
assumed that there could be a decision to sell an
investment with the presumption of an absolutely sound
economic decision, the income not received and taken from
the principle and then placed into the Earnings Reserve
Account. He questioned if that was an intended division.
Senator Therriault did not know how the Trustees would
interpret that language and that it might have to be
modified in order to be made clearer.
Representative Hawker interjected that would be an
important distinction. Point #2 creates a strong desire on
his part to provide the greatest assurance that whatever
changes made would not compromise the ability of continuing
the dividend. Some earnings would be used for public
services and that the qualification of "received" would
apply only to realized earnings available for
appropriation. The biggest problem in the current
structure is that the Earnings Reserve Account would be
within the Permanent Fund but subject to appropriation. He
thought that it would be possible for someone with ulterior
motives to manipulate investment policy within the fund.
Likewise, they would be able to sell, which would change
the amount in the Earnings Reserve Account. Representative
Hawker was troubled that action might create in the
constitutional mandate, two buckets of money and subject to
human manipulation. Representative Hawker asked if there
were sidebars that would protect the State.
Senator Therriault understood that under the current
system, there could be no possible manipulation. There
might be pressure to sell in order to spike the earnings.
If the State moved to a Percent of Market Value system, he
thought that the stream of revenue off the account could
spike the earnings. He proposed that nothing could be
changed if something was sold, and would not change the
value of the fund with no motivation to change the revenue
stream if it was 5% of the total value. He believed that
the system proposed in Amendment #3 would lend itself less
to public pressure.
Representative Hawker summarized that the amendment would
place the Earnings Reserve into a separate bucket in the
Constitution and that it would be protected. The 5% factor
would still be based on aggregate value of the fund. He
asked if there would be a secondary constraint and if there
was no money in the Earnings Reserve Account, then would
there be no money left to withdraw from that fund. Senator
Therriault explained that possibility could only exist in
the first couple years, after the establishment of the Sub
Account. Thereafter, and if a healthy balance is
maintained, the State would be able to weather any kind of
bear market.
Representative Hawker thought that the probably of the
State having a disastrous market in the near future was
slim. He referenced Senator Therriault's definition of
income. As indicated, a transition into the new mechanism
would take place, making certain that there is income
coming into the Earnings Reserve Account to support a draw.
He noted that specific language indicates that all income
from the Permanent Fund shall be deposited into the
Earnings Reserve Account. He inquired how the amendment
proposes to address loss. Senator Therriault thought that
the Earnings Reserve Account could absorb the losses.
Representative Hawker commented that an earnings bucket
would hold all gains, losses, income and the sale of
investments. Any market valuation change would be
accounted for on the income side. He recommended that area
of the bill to place Senator Therriault's language that the
net income be accounted for in the Earnings Reserve
Account, without receipt qualification accounting for the
value change in the Earnings Reserve Account and principal.
An amount currently exists because deposits have been made
to the fund from the State's oil and gas wealth.
Co-Chair Williams noted it would be difficult to change the
Constitution. The State does not know what is going to
happen in the future. If the bill was passed as originally
proposed, no money could be taken out and a situation could
exist where there might be no money left to pay the
dividend. Senator Therriault asserted that the Legislature
would attempt to balance out the knowns and unknowns and
that except for the first couple years, the possibility of
moving into an immediate down market, there would be enough
money in the Earnings Reserve Account to assure that a 5%
stream will be available.
Co-Chair Williams spoke to the deposit made to the Earnings
Reserve Account and that by incorporating the proposed
amendment, the State could be starting over again with a
down market. Senator Therriault stated that in the future,
when the Legislature considers making a shift to protect
the principal, they might have to waive it. Making a shift
should require appropriation if it suffers a governor's
veto. If the amount moved over to the earnings principal
was large enough and the Earnings Reserve Account was
small, there could be a continued dividend and then the
governor could not veto it, removing the cushion. It would
be preserved. He acknowledged that there might be some
disagreement of how big a cushion should be continued. He
recommended that enough should be left to guarantee that
the 5% would always exist. Senator Therriault stressed
that it is important to have a healthy Earnings Reserve
Account. Until the Earnings Reserve Account and the
protected principal are all managed together, then 5% would
often be the total. There should be more benefit to the
public given the method proposed in Amendment #3 as it
would protect against a down market. He thought that the
Earnings Reserve Account could be just as big as the
protected principal and that the Legislature could make a
policy for shifting money into either of the accounts.
Co-Chair Williams commented on placing money into the
principal every year. Senator Therriault stated that it
would be important to make sure that there are enough
earnings available in the Earnings Reserve Account to allow
for the 5% withdrawal, addressing transfers made to the
protected principal. He acknowledged the argument
regarding how much to leave in the reserve. There has
always been $100 million dollars remaining in that account.
There has always been a little pressure to make sure that
enough remained in that account for paying the next year's
dividend. Co-Chair Williams pointed out that there are
"politics involved".
Co-Chair Harris asked about the point made by
Representative Hawker regarding the income and to identify
what qualifies as income and loss.
BOB BARTHOLOMEW, CHIEF OPERATING OFFICER, ALASKA PERMANENT
FUND CORPORATION, DEPARTMENT OF REVENUE, explained that
currently as written, the constitutional amendment and the
proposed Amendment #3 would continue to do the accounting
as it is done at this time. There are two buckets for
income or earnings. The unrealized earnings, which result
from an asset going up in value after it is bought and
defined in the interpretation of the language remaining
"Shall be deposited as soon as it is received". He pointed
out that there is a solid record of what that means. When
the assets are sold, the realized income goes into the
realized earnings reserve. As written, the 5% available
for appropriation would come from the realized Earnings
Reserve Account.
TAPE HFC 04 - 69, Side B
Co-Chair Harris asked what would happen to the principal
and/or the loss. Mr. Bartholomew commented that they would
be treated just like the gains. The unrealized loss is
currently part of the principal allocation principle. When
a stock is sold for less than it is paid for, that becomes
a realized loss and goes into the Earnings Reserve Account.
Co-Chair Harris thought that was more difficult to
understand. A gain would be money going in. He asked if
money would be taken out of the Earnings Reserve Account
and deposited into the principal to make up the loss. Mr.
Bartholomew said no, but instead would handle it the same
manner it is currently is done. In the middle of a bear
market, there were many realized losses and they are
reflected in the Earnings Reserve Account. That account
goes up when there are gains and down when there is a loss.
The portions that are in principal, when it is an
unrealized loss, would stay if it was an unrealized loss.
The existing rules of the Permanent Fund were written
twenty-five years ago and are a little outdated. He
proposed that the area that should be discussed is
treatment of gains and losses.
Co-Chair Harris questioned if there are losses from the
principal, would they be made up through the Earnings
Reserve Account. Mr. Bartholomew responded that, today, as
written and as described, the principal value would be
reduced until the investments were sold. If there are
losses in the stock market, the balance of the fund can
fall below the principal level, which has happened. That
is a rare situation. If stocks were sold, that would bring
down the balance of the Earnings Reverse Account.
Co-Chair Harris asked what would happen if the balance
wasn't large enough in a down market. He asked if that
would put the Board of Trustees in a situation where they
would have to take a loss. Mr. Bartholomew observed that
there are short to mid term risks, which they believe works
over the long run. If there is a large amount of
unrealized earnings and the realized earnings account has
little income paid out, the balance could be affected
through the selling of investments. Historically, the
Board has deliberated on that issue and taken action. The
primary policy is to not to make decisions based on what
goes in and out of the Earnings Reserve Account and the
decisions to sell should be based on the market.
Co-Chair Harris understood that the amendment attempts to
protect the principal in the Constitution. Mr. Bartholomew
pointed out that Section 1 of the amendment makes the
distinction between protecting the principal or moving to a
pure percentage of market value so that the 5% spending
limit provides statutory guardrails that prevent from over
spending when income is not available.
Representative Joule questioned if the amendment would
impact the sweep. Mr. Bartholomew responded that he had
not been involved in the process to determine the CBR
sweep. Senator Therriault did not think it would impact
the sweep, noting that the Court's have determined that the
Permanent Fund and the Earnings Reserve Account are not
sweep able accounts.
Representative Hawker questioned if the value of the
principal could erode over time. He inquired if those were
issues with the existing structure and if they could be
resolved through a pure POMV methodology. Mr. Bartholomew
noted that the original POMV and the amendment could
achieve the goals of the Trustees, which are, in good
years, spend only the sustainable yield of the Permanent
Fund and overtime, 5% of the total value. The amendment
allows a risk in the near term that there could be less
than needed for a full distribution during extended down
markets in the short term. He added that the issue of
principal is a public image concept. Near term good
markets would reduce the risk. Arcane accounting methods
would be retained. The Corporation knows that they can
deal with continuation of the current accounting methods.
Senator Therriault observed that the Trustees are
advocating for the long-term health of the asset. The
downside of the accounting method would be done away with
through the pure Percent of Market Value and if the public
does not accept the POMV method, nothing would change.
Representative Hawker acknowledged the controversy and felt
that the Committee should put forth the best policy call.
He indicated his concern with Amendment #3.
Co-Chair Williams added that the Committee has taken public
testimony on the Percent of Market Value for over a year
and that there has not yet been public testimony taken on
the proposed amendment. He expressed support for Version
/U of the legislation. He observed that the amendment,
reflecting the Senate version, could be discussed when the
Senate bill moves to the House floor. Senator Therriault
emphasized that the language in the Senate version has been
debated and that the House should not lose sight of what is
possible while striving for what is perfect.
Representative Joule voiced his support for Section 2 of
Amendment #3. He suggested that section could be added to
Version \U of the bill.
Co-Chair Williams stated that HJR 26 would be HELD in
Committee for further consideration.
ADJOURNMENT
The meeting was adjourned at 10:26 A.M.
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