HOUSE BILL NO. 231 "An Act relating to income of the Alaska permanent fund, to the Alaska Income Account, and to permanent fund dividends; and providing for an effective date." HOUSE BILL NO. 232 "An Act making a special appropriation from the budget reserve fund under art. IX, sec. 17(c), Constitution of the State of Alaska, to the Alaska Income Account; and providing for an effective date." Discussion occurred regarding the opportunity for the public to have input on HB 231 and HB 232. PHIL OKESON, FISCAL ANALYST, LEGISLATIVE FINANCE DIVISION provided information on HB 231 and HB 232, The Healthy Alaska Plan. He noted that the "Do Nothing" assumption is built on the Department of Revenue's spring 1999 Forecast of moderate new oil revenue. The average price per barrel would go from $13.57 in the year 2000 to $27 dollars in 2020. The Department of Revenue forecast only includes known wells. He maintained that it is "probably not realistic to believe that we won't have any new production, coming on line in the future." Mr. Okeson explained that the Do Nothing Plan estimates 25 percent of potential fields would come on line. Some potential fields have a 100 percent probability of coming on line. The bulk of fields are still speculative. There is no new revenue included in the proposal for the first two years. The third year includes $4.5 million dollars for new revenue. New revenues rise to approximately $150 million in 2012 and drop back to $140 million dollars in the year 2020. He maintained that this is a relatively conservative assumption. The permanent fund is estimated to earn 7.75 percent on its total returns under the current asset allocation structure. There is a 1.45-percent growth allocation for formula education only. The formula education line is the only aspect of state government that has a built in growth factor. Permanent fund dividend recipients are anticipated to grow at 1.1 percent. Representative J. Davies maintained that the Do Nothing Plan should assume the same equity limits as the Health Alaska Plan. Co-Chair Mulder acknowledged that the Health Alaska Plan includes increased equity limits and stated that the Do Nothing Plan would be amended to contain the same equity limits. Representative J. Davies pointed out that the dividend rate has been growing at 1.6 percent over the last 5 years. Mr. Okeson noted that the Do Nothing Plan averages earnings over a 5-year period. He reviewed chart 2 on page 7 of Attachment 1 (copy on file). He observed that the Constitutional Budget Reserve would run out in the year 2002 or 2003 under the Do Nothing Plan. The earning reserves would be used in the out years. Unrealized gains would be used when the earning reserves run out. The permanent fund dividend calculation is based on realized gains. Income from stocks sold and interest income from bonds are included. As unrealized gains are realized the dividend calculation would increase. More would be paid out in dividends at the time that savings accounts are running out due to the dividend calculations. At this point unrealized gains would run out and the only thing left in the savings account would be the corpus of the permanent fund. The corpus of the permanent fund cannot be used to pay dividends. Dividends would then crash down. Managers would be forced to sell stock to get cash value out of a realized gain in order to pay the dividend. This can cause problems if it is not a good time to sell the stock. There would still be a slight dividend to pay for government if government goes not grow beyond the base amount which only includes a 1.45 percent growth for education. If government costs rise the dividend could be lost. Co-Chair Mulder asked how a stock market correction would affect the plan. Mr. Okeson stated that a major correction or crash would be detrimental to all of the plans. He stressed that the question is what is the worst case scenario. He stated that a sustained flat market could force a situation where there is not enough earnings reserve to pay the dividend. Co-Chair Mulder asked how a one-year down turn in the stock market would affect the plan. Mr. Okeson stated that if there were a bad year without a correction the calculations would be moved back. In response to a question by Representative Foster, Mr. Okeson explained that the dividend crash would occur because of a depletion of the savings accounts. The only way to pay for government would be to realize gains. When gains are realized, the dividend calculation forces a higher and higher dividend until the only thing that is left is the amount that the corpus gains each year. Vice-Chair Bunde pointed out that a tax could replace the dividend. Mr. Okeson observed that it would take a one and a half billion dollars in taxes to keep the dividend up. Mr. Okeson emphasized that the decision to save must be made by 2004. By 2011 unrealized gains will be gone. This causes a spike in the dividend. The permanent fund corpus would continue to grow due to inflation proofing and dedicated oil revenues. All other savings accounts would be depleted. Interest from the corpus would not be enough to fund dividends, inflation proof the fund and pay for government. Co-Chair Mulder pointed out that the nexus would occur somewhere between the years 2006 and 2008. At this point the Constitutional Budget Reserve and the Earnings Reserve accounts would be depleted. Unrealized gains would be the only remaining source for dividends. Mr. Okeson demonstrated that the state's $28 billion dollar savings account has to grow by 3 percent each year in order to retain the same purchasing power. By the year 2020 the permanent fund would have to be $52 billion dollars. He maintained that this amounts to "robbing from your children and your grandchildren." At this point the only option is to take from the corpus. Representative J. Davies pointed out that when the crash point is reached the dividend would no longer exist. Mr. Okeson noted that there would be a $10 to $12 billion dollar difference. Mr. Okeson noted that the deficit would be plugged by first using the Constitutional Budget Reserve. Then the Earnings Reserve Account would be used. After that realized gains would be used and finally permanent fund dividends. Vice-Chair Bunde pointed out that the dividend would reach a point where it would be to small to be worth running the program. Mr. Okeson agreed that the cost to administer the program could be greater than the amount distributed. Representative Williams asked how much the state would receive from the corpus of the fund to run government. Mr. Okeson noted that the corpus would earn approximately $1.5 billion dollars after inflation proofing. Mr. Okeson discussed the Healthy Alaska Plan. The plan is based on the Department of Revenue's spring revenue forecast and an assumption that the permanent fund would earn 8.4 percent. The plan requires greater flexibility for the fund's asset allocations. The plan requires continued constraint on government spending, sustainable reductions of $40 million dollars in the current year, one-time cuts of $35 million dollars in the current year, and $30 million dollars of sustainable cuts in the next year. Spending would remain flat in the third years. After the third year a 1.45 percent increase would be allowed for education, the University, public safety, transportation and maintenance. These were considered to be essential services. In the year 2002, there would be an additional $50 million dollars for capital spending. This would grow at 1.45 percent in subsequent years. Population for dividend growth would remain at 1.1 percent. In response to a question by Representative Williams, Mr. Okeson explained that the $50 million dollars for capital spending would be in addition to the $85 million dollars included in the primary years. Co-Chair Mulder acknowledged that an excess of $200 million dollars is needed to maintain the current infrastructure in the state. Mr. Okeson further explained that the plan would have a payout of 5.25 percent of the market value of the fund. This would be based on a five-year period, after the transition period. For example, the FY 2000 budget would be based on FY 98. This would also lower the payout percentage over years. A $1 thousand dollar dividend would be guaranteed through FY 2001. Afterwards, 42 percent of the payout would be dedicated to future dividends. Dividends would be inflation proofed. In response to a question by Vice-Chair Bunde, Mr. Okeson explained that in the first couple years of the plan the $1 thousand dollar dividend would be guaranteed. Afterwards, stabilization procedures would help reduce fluctuations. Earnings in any given year can vary. If a percentage of market value of assets are used the variation will be smaller. It would float with the market. The market tends to increase overtime. Representative Grussendorf asked if there would be a minimum of $52 million dollars in the corpus of the fund after 20 years. Mr. Okeson stressed that courage is needed to stay the course in markets. Co-Chair Mulder pointed out that it would be similar to the Teachers' Retirement System. Mr. Okeson pointed out that the dividend would be endowed. The dividend is not the shock absorber. The general fund spending is the shock absorber. Mr. Okeson emphasized that up turns in the market would help weather the down turns. It would be unusual for the market not to increase overtime. He explained that the deviations over-time are smaller. Representative Austerman observed that the Income Account could be the buffer. Co-Chair Mulder agreed and added that the corpus of the fund would never be jeopardized. Representative Williams asked how a 42 percent payout was derived. Mr. Okeson explained that 42 percent payout would result in a $1,000 dollar dividend and is sustainable. In response to a question by Representative G. Davis, Mr. Okeson explained that an endowment is based on a payoff percentage that does not exceed the long-term, real rate of return. Representative J. Davies referred to spreadsheets on the Constitutional Budget Reserve yield. Mr. Okeson explained that the Constitutional Budget Reserve is moved into the Alaska Income Account. There are still monies that would be deposited into the Constitutional Budget Reserve with the assumption that the funds would be transferred into the Alaska Income Account. (Tape Change, HFC 99 - 123, Side 2) REPRESENTATIVE ETHAN BERKOWITZ asked what the dividend amount would be for the years 1999, 2000 and 2001, if it was based on a 42 percent payout. Mr. Okeson thought that the dividend would be would be just under $1 thousand dollars. Mr. Okeson referred to graph 4, on page 1 of attachment 2 (Permanent Fund Dividend per Capita). He reiterated that the dividend would be inflation proofed. Mr. Okeson discussed graph 2 on page 1 of attachment 2 (Alaska's Savings Accounts). He observed that the permanent fund corpus continues to grow, but at a smaller rate. The inflation proofing would be kept in the Alaska Income Account. He observed that this is because the corpus is constitutionally protected. He pointed out that this would allow a larger source of cash to ride out worst case scenarios in the market or a natural disaster. Vice-Chair Bunde noted that all of the accounts are invested in the same manner. Mr. Okeson reviewed graph 7 in attachment 1 (Comparison of Savings Accounts, Health Alaska Plan Vs Do Nothing Plan. He pointed out that there would be a greater growth under the Healthy Alaska Plan. If there were no change there would only be corpus without any ability to change. He discussed graph 5 on page 1 in attachment 2. Projected savings would grow. The deficit would be filed entirely by revenues generated by non-petroleum and petroleum revenues and the 5.25 percent payoff on the earnings. Savings accounts would not be affected. He observed that there is a slight rise in education, university, and essential services. There would also be a rise in the dividend and a flat general government expenditure. Mr. Okeson explained that there would be a smaller growth under the 7.75 percent scenario. Representative J. Davies asked if the management cost of the fund was included. Mr. Okeson stated that it was included at 15 basis points. There are $30 to $50 million dollars included for management costs. Vice-Chair Bunde noted that if other revenue sources are developed the funds could be used in any manner. Mr. Okeson stated that the payoff percentage could be changed. There is nothing that precludes new revenues from being used in any manner. Vice-Chair Bunde stated that new revenues could be used to support services. Representative Austerman clarified that 50 percent of oil revenues go to the permanent fund corpus. Vice-Chair Bunde further explained that government would not be restricted to $1.5 billion dollars for state government support. There is a potential for additional revenues. Mr. Okeson added that a possible gas pipeline was not included. He stressed that there are a number of resource development potentials. Representative J. Davies noted that there is no mechanism for tourism to contribute toward state government. He questioned the source of new revenues included in the plan's projections. Mr. Okeson clarified that new revenue sources were not identified. Representative J. Davies referred to graph 1 on page 1 in attachment 2. Mr. Okeson explained that $285 million dollars would be moved from general government expenditures to essential services in 2002. The majority plan reduction is also included. Members provided suggestions for new scenarios. Under a scenario by Co-Chair Therriault, an addition of $100 million dollars under Healthy Alaska Plan in sustainable reductions resulted in a growth of dividends to $1,800 in FY 2020. The corpus also grew to $71 billion dollars. Even a sustainable reduction of $500 million dollars without any other change would result in a loss of dividends over the long run. The Constitutional Budget Reserve would last until 2004 or 2005. By 2017 all the savings accounts would be gone. He added that a six million-dollar reduction could be replaced with the same amount in taxes. Representative J. Davies asked for a scenario that did not include the reduction in government spending in the Healthy Alaska Plan. Under this scenario there would be a $7 million dollar loss in reserves. The dividend would rise to $1,400 instead of $1,600 dollars. He explained that even without the $100 million in reductions they would be above where they need to be. Representative Berkowitz asked for a scenario that would keep the Constitutional Budget Reserve separate. Mr. Okeson explained that if the Constitutional Budget Reserve were taken out of the scenario that the intergenerational graph would go below the line. The dividend would drop to $800 dollars and would only rise to $1,200 dollars. The Constitutional Budget Reserve would grow on the side. Co- Chair Mulder noted that there would be a third savings account that would generate interest, which could displace general funds. There would be approximately $240 million dollars generated. A higher amount could be taken for dividends because less would be needed for general funds. Mr. Okeson noted that if the dividend were increased to $1,000 dollars to meet the statutory requirement then the dividend would not raise as high. Vice-Chair Bunde pointed out that the Constitutional Budget Reserve would be earning at a lower interest rate if it were held separate. Mr. Okeson stated that the Department of Revenue might not agree. He stressed that the point is how long there would be before it is tapped for investment. Vice-Chair Bunde stressed that there would not be a comfort level for investment. Mr. Okeson noted that every $100 million dollar change has a $8 million dollar change for every subsequent year. The earning potential would be gone forever. He stressed that a systematic approach is the right way. Co-Chair Mulder noted that the Constitutional Budget Reserve is not inflation proofed. Representative Berkowitz stated that if the Constitutional Budget Reserve were not rolled into dividends there would be an additional 42 percent on the rate of return. Mr. Okeson agreed but added that it would occur as a result of lower dividends. Representative J. Davies noted that the Constitutional Budget Reserve would not have to be deposited into part of the fund. Co-Chair Mulder felt that multiple accounts are confusing to the public. The perception is that there are dozens of savings accounts that can be tapped. The plan would consolidate existing savings accounts into two. Vice-Chair Bunde added that there would have to be a strong level of trust that the corpus of the Constitutional Budget Reserve would not be available for appropriation, so that long term investment can occur. Mr. Okeson observed that there would not be as great a shock absorber in bad markets. Representative J. Davies noted that changes to the Constitutional Budget Reserve takes _ votes. The Alaska Income Account would only need 21 votes. Co-Chair Therriault stressed the need to keep an eye on the intergenerational line. Mr. Okeson noted that purchasing power could not be retained without a $600 to $700 million dollar tax or cut. He pointed out that there would be significant job loss with a reduction of $600 million dollars. Co-Chair Mulder recalled that under the status quo proposal there would have to be $350 million dollars of new taxes, $125 million dollars in additional cuts and a cap on the dividend of $1400 hundred dollars to protect the purchasing power. Mr. Okeson stressed that the models can work in a variety of ways. He emphasized that they are based on assumptions that the legislature provides as reasonable and can be lived with over the long term. (Tape Change, HFC 99 -124, Side 1) In response to a question by Representative J. Davies, Mr. Okeson stated that a little more than half of the purchasing power would be lost over 20 years if the money is not inflation proofed. Mr. Okeson emphasized that the Healthy Alaska Plan does not take anything off the table for future use. Representative Austerman stressed that the dividend would be reinvested not eliminated. Representative G. Davis stated that the public perception is that the dividend would be used to increase government. He clarified that it would be used to maintain the status quo with a slight reduction. Mr. Okeson reiterated that under the Do Nothing Plan the Constitutional Budget Reserve is eliminated and the earnings reserve would be used up. When the earnings reserve is eliminated unrealized gains would be used. This would force up the dividend as they are sold. When all the unrealized gains are sold the dividend would crash because the corpus is all that would be left. He emphasized that the administrative cost would be the same for a $100 dollar check. He maintained that the goose that lays the golden egg would be killed. He stressed that Alaska is in a unique position. He stressed that it is a questioned of providing a systematic approach for a long-term solution. He concluded that a systematic approach for a long-term solution would take courage and discipline. Co-Chair Mulder observed that the legislation is fairly simple. The funding is based on market value to add stability. There is no major fluctuation to the dividend. There would be greater certainty to the future of the dividend. Representative G. Davis observed that the average permanent fund dividend over past years is approximately $800 dollars. Representative Foster pointed out that it would be another 25 years before the dividend doubles. Mr. Okeson explained that the last 20 years has been one of the best bull markets. The assumptions are based on a lower average of 8.25 percent under the Healthy Alaska Plan. Some of the weaknesses of the old system have been hidden by the fact that there have been exceptional bull markets during the life of the plan. Co-Chair Mulder added that the legislature has never spent any of the earnings of the fund. The excess earnings have been deposited back into the corpus. Representative Grussendorf expressed concern that there would be cuts to areas that affect the private sector and the economy. He noted that the plan protects government service but does not emphasize areas that help to develop the private economy in the state of Alaska. Co-Chair Mulder emphasized that future legislatures cannot be bound. He stressed that there would be on going discussion. There would be a certain amount of flexibility. The goal was to allow an intergenerational gap to allow for an increase in spending without jeopardizing the plan. Representative J. Davies echoed concerns by Representative Grussendorf, but added that the legislation is a good first step. He referred to page 1, line 13 and questioned if there is a better way to maximize the earnings. Co-Chair Mulder explained that the true potential would not be earned if the entire amount were deposited into the general fund. Mr. Okeson stated that the intent is to allow the deposit after the date. It could be done overtime. It could be kept in the fund earning interest. He noted that draws on accounts tend to come early. However, the dividends come out at the end of the year. Representative J. Davies agreed with Mr. Okeson's interpretation. Vice-Chair Bunde maintained that the public has bound legislatures. Discussion occurred regarding the public comment process. Co-Chair Mulder provided members with a sectional analysis on HB HB 231 and HB 232(copy on file). Representative Kohring maintained that the plan would not eliminate the incentive to continue with sizable reductions and reforms for government. Co-Chair Mulder discussed proposed public hearings regarding the Healthy Alaska Plan. HB 231 and HB 232 were HELD in Committee for further consideration.