SENATE JOINT RESOLUTION NO. 35 Proposing amendments to the Constitution of the State of Alaska to guarantee the permanent fund dividend, to provide for inflation proofing, and to require a vote of the people before changing the statutory formula for distribution that existed on January 1, 2000. Senator Green testified that she introduced this resolution for the opposite reason of SJR 33. Senator Green explained that this plan takes the current statutory formula for dividend distribution and places it into the Alaska Constitution as an amendment to Article 9 Section 15. Senator Green continued that the resolution would guarantee that the eighteen-year history of earnings distribution was preserved, the dividend was protected, the current method of inflation-proofing the corpus of the fund was unchanged and includes no new taxes. Senator Green surmised that once Alaskans felt confident that the dividend program was safe for future generations and that the integrity of the permanent fund was protected, the discussions could then begin on what to do with any excess earnings. Senator Green thought this resolution was the most important step the legislature could take to show Alaskans that the promise would be kept to protect the dividend program, inflation-proof the corpus and ensure the future of the permanent fund for generations to come. Senator Green shared that one of the issues that would be brought to the Committee's attention regarding this resolution was the tax question. She avowed that there was no proof that the U.S. Internal Revenue Service (IRS) would tax the permanent fund any differently after this amendment to the constitution was adopted. On the other hand, she conceded, there was no proof that the taxation would not change. She disclosed that the IRS had never taxed the program in the past and that to her knowledge, the Permanent Fund Corporation has never requested an opinion on the matter from the IRS. Senator Green spoke of warnings that the legislature would lose control over the permanent fund by placing it into the constitution. She assured that the question of who qualified and who received the dividends would always remain in the legislature's perusal. She stressed that this was probably the sidebar that protects and keeps the dividend program from being reclassified for the purposes of federal taxation. Senator Green declared that she did not believe the IRS would risk losing the revenues it currently receives from taxes on dividends. She cited that since the beginning of the dividend program, $8.9 billion had been distributed as dividends and at a conservative rate of 15 percent, she calculated the IRS has received $1.34 billion. Senator Green continued that the legislature could still change the dividend program or the method of inflation proofing through a constitutional amendment approved by a vote of the people. Senator Green mentioned SJR 18 offered the previous session that also proposed to place some of the dividend provisions into the constitution. She talked about the differences in the language between this resolution and SJR 35, saying the resolution before the Committee at this time places only the current statutes relating to dividends and inflation- proofing into the constitution. Excess earnings, she added, are left in statute under the provisions of SJR 35. Senator Green asserted that this resolution would guarantee the legislature access to excess earnings in times of need. She stressed that before any excess earnings could be spent for government services, the public needs to be assured the dividend and inflation proofing was protected. She referred to the booklet, An Alaskan's Guide to the Permanent Fund, saying she thought it clearly states the intent of the program when it was established. [Copy on file] She emphasized the words, "generations to come" as repeatedly mentioned in the booklet. She cited the reason for the permanent fund was to "have less state income" and that it, "reduces the opportunity for excessive state spending." She told the Committee the legislators needed to remember this statement explains why the dividend program exists and why it must continue. Senator Green then addressed a collection of spreadsheets that show models and projections of the impact of various plans on the permanent fund and the dividend program. She cautioned that many more such spreadsheets would be presented and that they are all "suspects" because none has ever proven to be 100 percent correct. She noted this applied to any scenarios that either confirmed or refuted the objections of this resolution. She did however reference the spreadsheets contained in the handout that gave five scenarios ranging from spending none of the permanent fund excess earnings to spending all of the earnings for government services. According to these figures, she surmised that by the year 2010, the individual dividend changes by $100. Therefore, she asserted there was stability built into the permanent fund dividend program that was the envy of other dividend funds. She concluded that simply protecting the dividend and inflation proofing and allowing investments to continue was in the best interest of Alaskans. Senator Leman appreciated and shared the sponsor's desire to keep the fund a permanent fixture. However, he warned that under the current structure of paying dividends based on realized gains, there was a high likelihood the dividend would end in eight or nine years. He asked why the existing structure was retained in the resolution instead of allowing a change to calculate dividends based on a percent of the value of the entire fund. Senator Green responded that she did not think the fund would be eliminated under the current practice of calculating dividends. Senator Leman relayed his understanding of how the fund would greatly diminish under the existing methodology. He qualified that while it has worked for the first 20 years of the program it had a high risk of failure. The concept of enshrining this method in the constitution concerned him because it could backfire. Co-Chair Torgerson clarified Senator Leman's argument derived from a model presented by Callan and Associates that predicted if inflation rose considerably, the scenario of a depleted dividend could occur. Senator P. Kelly relayed that Senator Leman's concern was that if the current structure was placed into the constitution, then the dividend amount would not be drawn down. Senator P. Kelly thought those assumptions were based on the premise that the dividends would be paid first from excess reserves, then the unrealized gains and finally the principal of the fund. However he was unsure that would happen with the program enshrined in the constitution. Senator Donley thought Senator Leman was right. He spoke to a memo he had sent to members at the start of the year regarding this matter laying out that if certain events occurred, Senator Leman's predictions would occur. Senator Donley had proposed a solution to a particular caveat in the dividend calculation formula. His explained his suggestion would change the calculation in the event of certain occurrences. Senator Wilken requested a graphic representation, such as a pie chart showing the program today and what would occur if the measure were to pass. Senator Green said she would comply but noted that the resolution actually changed nothing from the current system. Co-Chair Torgerson shared that he wrote a memo to the executive director of the Permanent Fund Corporation requesting an official position on this legislation, specifically as it related to the tax exempt status of the corporation. He received a response saying the matter would be taken up at the March 8 Board of Directors Meeting. RON LORENSEN, Attorney, Simpson, Tillinghast, Sorensen and Lorensen, Attorneys at Law, serving as outside council to the Permanent Fund Corporation for five years testified about a legal opinion obtained by the corporation on the taxation question. Mr. Lorensen gave a history of the possible taxation of the dividend and what could be done to minimize the tax. He recounted how the corporation sought two outside legal opinions in 1988, each of which took a different approach to the question. He said the opinions both advised that the permanent fund should not be taxable and suggested certain changes to improve the argument that it should remain tax exempt. He remarked that most of those suggested changes were subsequently implemented including a number of changes made by the legislature in 1994. As a result of the changes, he stated that it was the general view that an argument claiming the permanent fund was subject to taxation would be very weak. Mr. Lorensen continued sharing that in 1998, a similar proposal for a constitutional amendment, SJR 18, was introduced in the legislature. At that time, he said, the board felt it was advisable to seek an update of the earlier tax opinions to learn if the changes made had an impact of minimizing tax concerns and also to assess how the proposed changes might implicate arguments to make the fund taxable. That opinion, Mr. Lorensen informed the Committee, updated the earlier opinions to incorporate the adopted changes to the fund and also address the impacts of SJR 18. He relayed that the opinion advised that imbedding the dividend program into the constitution would create a significant risk of subjecting the permanent fund income to taxation. He cited the opinion gave two inter-related reasons, one was called a "private interest" in funds. He explained that when a private interest was created in government funds, the funds lose the governmental tax immunity protection. The other reason cited in the opinion, he continued was whether or not the income accrues to the state. He expounded that the underlying question was whether the state legislature, the body with the power of appropriation, also has the power of appropriation with respect to that income. He pointed out that by imbedding the appropriation of the dividends permanently into the state constitution, the constitution takes the appropriation power away from the legislature. As a result, he asserted the argument strengthens that the income no longer accrues to the state and becomes a private interest and subsequently becomes taxable income. Mr. Lorensen said that the board had been concerned about the confidentiality of that opinion because of the conclusions contained, which could come back to harm the state if the information became public. He told the Committee that he had communicated to the board, the co- chair's conviction that this opinion was an important aspect of the public policy debate. Mr. Lorensen disclosed that the board has authorized him to provide a copy of the opinion to the Committee "with no strings attached." He expressed that it was the board's preference that the information remains confidential but that the board offered the opinion to the Committee to use as it deemed appropriate. AT EASE 10:26 AM / 10:27 AM Co-Chair Torgerson relayed that he had a lengthy debate with the corporation and Mr. Lorensen about whether or not this opinion should be made public. Co-Chair Torgerson said that during the break, another Committee member suggested to him that the opinion should not be accepted if it could jeopardize the permanent fund. However, he concluded that the question of whether to enshrine the dividend in the constitution is a larger public policy question. He said in order for that question to be considered, Alaskans need to know the potential consequences. Co-Chair Torgerson stated that he was opposed to the Committee having an executive session to review the contents of the legal opinion only to emerge with a decision made without any public input or public record. Co-Chair Torgerson asked the witness whether he thought that releasing the opinion to the public would jeopardize the status of the permanent fund. Mr. Lorensen answered that he did not believe that releasing the opinion would jeopardize the permanent fund. He added that the opinion concludes that the arguments are stronger regarding the tax exemption of the current status of the fund than if the dividend program were placed in the constitution. There was some discussion between Co-Chair Torgerson and Mr. Lorensen about the need for information provided to the Committee in a public hearing to be public information versus information garnered in an executive session. Mr. Lorensen concluded that while he was not convinced the opinion needed to be made public, he was prepared to release the opinion to the Committee to do with it as saw fit. Senator Phillips asked for specific clarification from the legal advisor to the corporation, Mr. Lorensen, if the tax on the permanent fund would greatly increase if the resolution were adopted. Mr. Lorensen affirmed it would be substantially greater, "from something well below 50 percent now to well in excess of 50 percent, I believe." When asked by Senator Phillips if he was guessing at this assessment, Mr. Lorensen qualified that "I'm just doing the best I can. I'm not the court. I'm not the ultimate decider." Senator Green said she knew the defining issue on the vulnerability of taxation was public interest versus private interest. She asked for a clarification of public interest. Mr. Lorensen responded that the matter was not a question of public interest versus private interest, it was a question of whether or not a private interest was created. He explained private interest applied to an individual citizen that was independently enforceable, or could enforce him or herself. He stated that placing the dividend program into the constitution would provide that private interest because it would allow a citizen to make a constitutional claim for the dividend if he or she did not get one. Mr. Lorensen continued answering Senator Green's question saying that the other issue was whether or not the legislature had the ability to exercise the power of appropriation over the money. Senator Green asked about the issue of whether the determination of who could receive the dividend was subject to legislative change. She wanted to know if that was considered when the board was discussing the taxability question and considering obtaining legal advice. She suggested the legislature could make eligibility determinations based on need, senior citizen status, or any permutation of demographic information. She thought that the private interest would not be established if the legislature had the option of redefining eligibility each year. Mr. Lorensen did not think this specific variable was raised with the attorneys. However, he stated Senator Green's suggestion probably did not address the question of whether or not a private interest existed at any one point in time. He explained that while who was entitled to the private interest could change, the fact that an underlying private interested existed, would not change. Senator Green commented that even if the constitution were amended as proposed in this resolution, a future amendment was possible through the same process. Therefore, she concluded that the legislature would always have some involvement in the dividend program through the budget process unless the corporation decided to distribute the dividends itself. Mr. Lorensen said the comments about amending the constitution were correct but that the legislature would not have control over the vote of the people, which would be required to pass an amendment. Co-Chair Torgerson thought that the Committee would have to read the opinion to understand the witness's private interest argument. Senator Adams worried that the federal tax rules were "governed by the creator," meaning that the federal government adopted laws when and how they benefited the federal government. He asked what amount the dividend would be using the model presented the previous year. Mr. Lorensen understood the question but did not know the answer. He did not know if the corporation had calculated those figures or not. Senator Adams restated his question to ask, if the fund lost tax immunity, what percentage or amount of the interest would the federal government take from the fund in the form of taxes. Mr. Lorensen answered it would be approximately 39 percent Co-Chair Torgerson asked if the board took a position on this resolution. Mr. Lorensen replied it had not. Senator Phillips wanted to know if the board would take a position if the legislature requested it do so. Mr. Lorensen could not speak for the board. ART GRISWOLD testified via teleconference from Delta Junction that he believed more research should be done on the tax structure, but once resolved, supported the resolution. LYNN BURKHARDT testified via teleconference from Homer that if the public asked the legislature to not spend the permanent fund, then it should not be spent. She talked about the payoffs of the oil industry compared to the environmental impacts. RALPH RECTOR testified via teleconference from Kenai asking why the tax would be so high because it should be calculated on the number of shareholders. "Keep your hands off of our money." JUNE BURKHART testified via teleconference from MatSu in strong support of the resolution and commended the sponsors. She believed that the fund was created for the benefits of all Alaskans forever. ORAL FREEMAN testified via teleconference from Ketchikan in agreement with the resolution. He repeated the previous speaker's comment that the fund was for all Alaska. CARL WASSILIE testified via teleconference from Anchorage in favor of SJR 35 saying he thought the tax concerns could be resolved with further discussion. Tape: SFC - 00 #58, Side A 10:47 AM JOHN GLOTFELTY testified via teleconference from Delta Junction in support of the resolution and questioned why the tax situation would change. MARY GRISWOLD testified via teleconference from Homer in opposition of the resolution although she did support the concept of protecting the fund. She suggested HB 411 was a better method. She gave detailed to explain her reasoning. JAMES SHOWALTER testified via teleconference from Kenai thanking the sponsors for introducing the bill, which he favored. He stated that it protects the oil revenues. SUSAN GIBSON testified via teleconference from Kenai in support of the resolution. She suggested nonessential services should be eliminated and that if done so, there would be enough funds for the budget. DALE BONDURANT testified via teleconference from Kenai about his understanding of the purpose of the permanent fund and his support of the resolution. LINDA ANDERSON testified via teleconference from MatSu that she thought the government had not been cut enough. JESSEE CHANDLER testified via teleconference from MatSu in favor of SJR 35. CLIFTON CHANDLER testified via teleconference from MatSu that he believed this resolution protected the permanent fund for his and his children's future. KEITH LIPSE testified via teleconference from MatSu thanking Senator Green for looking out for the public's interest in the permanent fund. WALTER ST JOHN testified via teleconference from Big Delta that the IRS would love SJR 33 to become adopted. ORVILLE MCETHY testified via teleconference from Kenai in support of SJR 35. He commented on the fast ferries in British Columbia, Canada and noted that Governor Knowles was planning to purchase two for Alaska. Co-Chair Torgerson ordered the resolution HELD in Committee.