HOUSE BILL NO. 411 "An Act relating to the market value of the permanent fund and to distribution of income of the permanent fund; and providing for an effective date." REPRESENTATIVE BILL HUDSON, Sponsor spoke in support of HB 411. He observed that House Bill 411 would be a step toward a long-term fiscal plan. House Bill 411 was introduced to give the Permanent Fund strength, security and stability far into the future. The legislation allows income from the Permanent Fund to be distributed as a percentage of market value. Permanent fund dividends are currently distributed under a realized return formula. He stressed that Dave Rose and other knowledgeable people recommended the market value concept. Distributing the fund income as a percent of market value has been discussed since the late 1980's. The Commission on the Future of the Permanent Fund, various fund trustees, the Long-Range Financial Planning Commission, the Fiscal Policy Council, and Commonwealth North have recommended this blueprint for strengthening the Fund. This legislation fits in with the Permanent Fund's long-term investment horizon. While not necessarily endorsing HB 411, the Permanent Fund Board supports a percent of market value approach and recognizes that continuing the present realized return formula could lead to distortions in distributions due to gain taking and asset allocation decisions made as part of good investment policy. Passage of HB 411 would allow the Permanent Fund Corporation to hold investments that historically need more time to mature. Another unique feature of the market value approach is that it produces a distribution program that is inherently more level. First and foremost, House Bill 411 protects the realized and unrealized assets of the Earnings Reserve Account. The Principal of the Permanent Fund is protected by the Constitution. Vice Chair Bunde pointed out that some of the earnings of the Permanent Fund are being used to hold harmless those that would lose their welfare benefits due to their permanent fund dividend. Representative Hudson reiterated that the proposal is but one possible element of a long-range fiscal plan. It is however, an essential element if the state is to close the fiscal gap. According to the most recent Department of Revenue prediction, approximately $413 million dollars will be needed to balance the 2001 budget and $736 million dollars will be needed to close the gap in 2002. He stressed that the state of Alaska has a serious fiscal problem. Representative Hudson maintained that HB 411 preserves and grows the permanent fund. Preserving and growing the Fund is an issue that he and others that support the plan felt they needed to respond to after the September 14, 1999 special election vote regarding use of the Permanent Fund. He emphasized that opponents of the advisory vote did not infer that some assets of the Permanent Fund could not be used and that the entire fiscal gap would not be made up with the Permanent Fund. The plan would maintain permanent fund dividends at the status quo or greater over the next 10 years of projected growth. Representative Hudson explained that the Earnings Reserve Account would also be protected and would maintain growth. The Earnings Reserve Account would grow from $3 billion to more than $8 million dollars under the plan. The Constitutional Budget Reserve would also be preserved. Vice Chair Bunde questioned if the pay back to the Constitutional Budget Reserve had been discussed. Representative Hudson noted that the state of Alaska is approximately $5 billion dollars in arrears to the Constitutional Budget Reserve. The Constitutional Budget Reserve now has close to $3 million dollars. He estimated that the Constitutional Budget Reserve would be depleted by the year 2005. He acknowledged that the pay back is a serious concern. He did not have an answer. Representative Hudson stressed that the cash flow of the Permanent Fund would be protected. Permanent fund dividends would continue at the same rate or greater. He maintained that the approach maximizes the predictability and stability of distributions. He maintained that it is an essential element of the plan. Statutory inflation proofing would be required. The Fund would earn approximately 8 percent over the long term. The first 3 percent of earnings would remain in the Fund for inflation proofing. After inflation proofing 5.3% of the earnings would remain for distribution to dividends and the General Fund. House Bill 411 allocates 75% of the distributions to the dividend and 25% to the General Fund. Representative Hudson noted that the plan includes 2 percent inflation for education and transportation spending. He maintained that timely action would come close to balancing the budget. Representative Hudson presented the Committee with charts to demonstrate the need for a long-range fiscal plan. He maintained that HB 411 would be the salvation of the permanent fund dividend and that it fits into the original intent of the Permanent Fund. He stressed that for every billion dollars of the reserve that is lost there is a corresponding loss of $80 - $100 million dollars in potential earnings. Vice Chair Bunde observed that individuals reduce their outflow to met their income. Representative Hudson pointed out that government has constitutional mandates such as education. Approximately $1 billion dollars goes into education and the university. The state of Alaska also has welfare and public safety responsibilities. He observed that the public wants more money for education, $17.5 million dollars more for the university and full funding for Power Cost Equalization. He stressed that the public would throw legislators out if they reduced state support. Vice Chair Bunde pointed out that there is a state budget of over $6 billion dollars for only 600,000 people. Representative Hudson observed that $1.6 billion dollars of the $6 billion total is allocated to the public in the form of the permanent fund dividend. The $1.5 billion dollar federal portion must be allocated as the federal government directs. The unrestricted general fund revenues are $2.1 to $2.2 billion dollars. Oil production is going down. The level of oil production has been reduced from 200 million barrels to 1 million barrels a day. Oil production is projected to drop to 800,000 barrels a day over the next 7 - 10 years. Vice Chair Bunde concluded that the state's budget could be divided into three equal parts: federal dollars, permanent fund dividends, and state expenditures. Representative Hudson stressed that there is a $417 million dollar deficient and a statutory responsibility to produce an available dollar for every dollar spent. Need exceeds the money available. The Constitutional Budget Reserve account is $4.5 to $5 billion dollars in the arrears. Representative Austerman observed that the plan would deposit 25 percent of the undistributed interest earnings in to the General Fund. Undistributed interest earnings are the amount left after inflation proofing. Dividends would be paid with the remaining 75 percent. He observed that HB 411 allows higher payment of dividends than under the status quo. The cost of government is projected to be short $700 - $800 million dollars. The flow of 25 percent of the undistributed interest to the General Fund would result in approximately $350 - $370 million dollars. The Constitutional Budget Reserve savings account would not need to be used. Representative Austerman pointed out that a tax base would be needed to supplement undistributed interest to the General Fund. Additional money from the oil industry, taxes and permanent fund earnings would be used to balance the budget. He observed that the figures are fluid. Representative Phillips clarified that there would be $350 million dollars in new revenues. New revenues would come from residents, industry, out-of-state workers and nonresidents. Representative Austerman provided members with four possible tax structures (copies on file). A retable sales tax, seasonal sales tax, a head tax similar to the school tax, and a flat income tax were addressed. He emphasized that the House Finance Committee is the appropriate place to discuss which method or methods should be used. Representative J. Davies spoke in support of a balanced revenue plan. The third piece of the plan would be revenue from industry. He provided members with two amendments addressing the corporate income rate (copies on file). The corporate income rate is a graduated tax structure. He observed that almost all corporations are at the top of the taxable rate. An increase in the corporate tax would raise an additional $100 million dollars. This would be a tax cut for some of the small and medium corporations. Addressing the ELF rate could raise additional funds. REPRESENTATIVE LISA MURKOWSKI stressed that options are being presented. She observed that no one is suggesting that all of the tax options be "rolled out on to the floor". The plan is an attempt to encourage discussions on a wide range of options. The longer there is delay, the fewer options that will be available. The result would be a higher level of taxes. She stressed the need to let people know what is available and emphasized that it is important to bring industry into the discussion. REPRESENTATIVE ANDREW HALCRO echoed remarks by Representative Murkowski. He observed that the public criticized the amount of public input. He noted that there were a number of reasons that people voted against the long- range fiscal plan in FY00. He pointed out that the market is volatile. "It is a dollar today, or $10 dollars tomorrow." GOVERNOR JAY HAMMOND testified via teleconference in support of HB 411. He observed that HB 411 obtains the first obligation to the public to take dividends off the table. He questioned if the interest rate is too high and asked why there was a three-year instead of five-year average. (TAPE CHANGE, HFC 00 - 115, SIDE 2)  Governor Hammond spoke in support of a public vote. He maintained that the public was unaware that there is money in the Permanent Fund that could be used without affecting permanent fund dividends. He stressed the importance of inflation proofing. He felt that the public would support a plan to use up to but no more than the amount of Permanent Fund earnings that are not needed for dividends or inflation proofing. He stressed that the public needs to be assured that the legislature would be prevented from using permanent fund dividend dollars without a constitutional amendment or a public vote. He observed that Governor Knowles promised that there would be a public vote and that the public may demand a vote before anything is approved. He stated that he supports a public vote but would not oppose passage of a ballot proposition to clarify the issue. He stated that he would support use of a reasonable percentage that would not impact the dividend. BOB STORER, EXECUTIVE DIRECTOR, ALASKA PERMANENT FUND CORPORATION provided information on the legislation. He observed that an interest rate of 5.3 percent would be on the high end of reasonable. He explained that the longer the time period the less volatile the payoff formula. A three- year average would reduce the volatility. Vice Chair Bunde asked if the dividend could get so high that there would be a negative impact to the state of Alaska in the form of the attraction to new residents. Governor Hammond pointed out that inflation grows as dividends grow. He did not think that the dividend would grow so large that it would be unreasonable when inflation is factored in. Vice Chair Bunde clarified that more than 2.5 percent of the earnings reserve is being spent for inflation proofing. Representative Austerman reiterated that the percentages can be changed and encouraged discussions to find the right amount. Co-Chair Therriault noted that an opponent of the September 14, 1999 advisory vote regarding use of the Permanent Fund to support state government used a quote by Governor Hammond to support his position. In response to a radio interview on May 18, 1998 Governor Hammond responded to the question: "When the Permanent Fund was originally established -- was the intent to use that money to fund government or was the intent solely to provide for a dividend program for the citizens?" Governor Hammond responded to the question: "I can't say what the intent of all those who played a role in establishment of the [Permanent] Fund might be, all I can tell you is what my intent was, and that was, in light of the circumstances prevailing at the moment, it [was] to confine the expenditures of the fund to dividends or reinvestment in the fund period." Co-Chair Therriault interpreted the quote to emphasize the circumstances prevailing at the moment. Governor Hammond pointed out that the circumstances have changed since the dividend was proposed and acknowledged that the legislature has made substantial additions to the Permanent Fund. He observed that the income tax was in place at the time the dividend program was proposed. He stressed that his intent was to place at least 50 percent of bonuses, royalties and severance taxes into the Fund. He observed that severance taxes were eliminated, royalties were reduced and the income tax eliminated. The original suggestion was that half of the earnings would go to dividends and the other half would go to state government. Inflation proofing was added, further reducing the amount available for government. He stated that when the tax was eliminated and the contribution rate reduced substantially, then in his view the dividends became the highest priority. He continued that as long as dividends are held harmless, that the circumstances of the moment would indicate that the surplus could be used for government purposes. He stated that a community dividend program would be in keeping with the idea of dividends and could be a repository for surplus funds not needed to pay dividends. A community dividend would go primarily to Alaskans, which is his biggest concern. A massive public education program is necessary to make the public aware that there are dollars available that are not required to keep dividends flowing. Representative Hudson asked Governor Hammond to consider language to institute a percentage on the limit of funds available for state government use. He observed that under HB 411 3 percent would go to inflation proofing and 75 percent of the remainder would be used to pay dividends and 25 percent would be go into the General Fund. He emphasized that the plan would place a statutory limit on what the legislature could spend. He suggested that a super majority vote could be further required for legislative access or change. He added that the Legislature is moving toward the establishment of an interim committee to discuss the issue with the public. He encouraged the former Governor to participate in interim hearings. Governor Hammond stressed that a requirement for a super majority vote would be the right step and added that a vote of the public could be required. He spoke in support of a super majority vote of the public to change the distribution. He stressed that the public hearing and education process is imperative, but was not sure how the public could be convinced. He observed that HB 411 doesn't touch permanent fund dividend dollars. Co-Chair Therriault stressed that a super majority vote could not be established by statute. They only super majority votes were established in the Constitution. Vice Chair Bunde pointed out that the dividend has been around for 20 years without legislative use. He felt that there was enough public pressure to prevent the legislature from spending dividend money. JOHN BROWN, PRESIDENT, FAIRBANKS LABOR COUNCIL, FAIRBANKS testified via teleconference in support of HB 411. He stressed that the original intent of the Permanent Fund was to take over as a revenue source after oil revenues declined. He stated that he wanted to see talk about reinstitution of an income tax. He stressed that an income tax would capture funds from those that work in Alaska but do not contribute to state services. It would also send the message that business would not carry it on their backs. Vice Chair Bunde added that the non-resident worker contribution might not be as large as many believe. He observed that 10 percent of Alaskan wager earners are non- resident workers and that the average salary of a non- resident worker is $13 thousand dollars. Mr. Brown acknowledged that it is only one part of the solution. Representative Moses estimated that there are 70,000 non- residents in Alaska earning a total of one billion dollars. Representative Phillips observed that discussions have occurred regarding the use of an income tax, sales tax, and head tax. She suggested that one option is to enact a small percentage of each tax. She noted that the income tax would capture funds from out-of-state workers, while a sales tax would capture funds from summer visitors. There are advantages to each and all are being considered. In response to a question by Vice Chair Bunde, Mr. Storer explained how the plan would change the calculation of dividends. The current formula takes 21 percent of the realized income over a five-year period. Realized income includes dividends, interest and capital gains on profits from the sale of securities. It does not include appreciation of the asset. A percentage of the market value takes systematic earnings of the average value of the fund, which is smoothed out over a period of time. This approach would smooth out the payout stream. A realized average is more volatile. Vice Chair Bunde noted that there is a risk that dividends could not be paid during prolonged depressed stock markets. He questioned the purpose of the constitutional mandate for the purpose of the excess earnings. Mr. Storer clarified that the purpose is to be used by the legislature, as they deem appropriate. JIM KELLY, LEGISLATIVE LIAISON, ALASKA PERMANENT FUND CORPORATION clarified that the 1976 ballot proposition stated that all income from the Permanent Fund "shall" be deposited into the General Fund unless otherwise provided by law. In response to a question by Representative Austerman, Mr. Storer explained that the Board did not take a position on the change from status quo. Individual board members recognize the advantage of a payout based on market value. IAN OLSON, FAIRBANKS testified via teleconference in support of HB 411. He stressed that oil is declining. He noted that: "Those that fail to plan, plan to fail." The plan protects and increases the permanent fund dividend and allows consideration of a broad base revenue increase. He cautioned the Committee not to take the plan to a vote of the people without a massive educational effort. He expressed support for income tax and a seasonal sales tax. DAVE JONES, KODIAK testified via teleconference in support of HB 411. He maintained that it is essential to address the long-term budget plan. He expressed support for a diversified revenue stream. He maintained that the original intent was to use earnings of the Permanent Fund when oil revenues declined. He maintained that HB 411 fulfills the original intent of the program while maintaining the permanent fund dividend. He noted that the revenue stream would be broad based. Alaskans must pay their share. He pointed out that he is not paying taxes. His permanent fund dividend exceeds his property tax. He spoke in support of income and sales taxes. He observed that the Constitutional Budget Reserve needs to be captured now and that it could be lost as a source of revenue, which would increase the likelihood that dividends would be affected. MARY GRISWOLD, HOMER testified via teleconference in support of the market value payout. She read from written testimony: I strongly support changing the distribution of Permanent Fund earnings to a percentage of market value payout This method protects the Permanent Fund principal and promotes a long-term investment strategy allowing our equity investments to reach their full potential. Although there are no performance guarantees with the market value approach, it does remove the dependence on volatile realized earnings and offers a more stable dividend distribution based on the real return of the Permanent Fund investments. HB 411 and a combination of reasonable taxes will provide funding for essential government services and set the framework for a successful long-term financial plan. I think a long range fiscal plan including better control of government spending and a combination of reasonable taxes should be developed before the Permanent Fund's earnings are tapped to meet government expenses. Assuming these conditions are met, I prefer starting with an 80/20 split of the payout because this preserves the present dividend value. Howeveradjusting 1 the dividend should remain a legislative option for balancing personal benefit and the common good for all Alaskans as other General Fund revenue sources are depleted. Shortchanging funding for essential public services or raising exorbitant taxes in order to sustain a large personal dividend does not serve our best interests or the purposes for which the Permanent Fund was established. I strongly urge you to keep the payout at 5%. This is commonly accepted as reasonable by most of the country's large endowments and is supported by the APFC's own predictions for a real return. It is better to err on the side of protecting the Permanent Fund's principal than on the side of increasing the amount of money available to spend. I would like to see language included in the bill to provide for the periodic transfer of money from the Earnings Reserve Account to the Permanent Fund principal to make sure the inflation-proofing earnings arc fully protected, such as was provided in HB1001. Several underperforming years could erode the value of the principal without such protection because the payout would exceed the real return as long as there were sufficient accumulated earnings in the reserve account to permit it. It is imperative to compensate for this by fully protecting the principal when the fund is performing well. I also urge the Legislature to start research on tax options at the earliest moment, to come up with a reasonable combination of sales and income taxes that most fairly shares the burden for funding public services among all those who benefit, including out of state workers and tourists. Representative Phillips observed that the Legislative Budget and Audit Committee would be working on ideas during the interim. EDDIE BURKE, ANCHORAGE testified via teleconference in opposition of HB 411. He quoted Ronald Regan: "Here we go again." He maintained that it is an effort to take money from the people. He stressed that the funds cannot be designated and that future legislatures cannot be bound. He referred to Rule 21. He stressed that there needs to be constitutional protections. He noted that reductions have been anticipated for a number of years. He stressed that Alaskans are not greedy, but that they do not want the legislature to spend their money. He observed that there is no cap on government growth. He maintained that it is a blank check written on different ink. He observed the absence of key legislators from the discussions. (TAPE CHANGE, HFC 00 - 116, SIDE 1)  Representative Phillips disagreed with remarks by Mr. Burke. She stressed that the Legislature is making no attempt to go into the corpus of the Permanent Fund. She added that under HB 411 that there is a greater return to the individual Alaskan in dividends than would exist under the status quo. The Legislature did not spend $600 thousand dollars to educate the public prior to the September 14, 1999 advisory vote. The funds were raised by the public sector. MARY RAYMOND, HOMER testified via teleconference in support of HB 411. She expressed relief that discussions have taken place regarding a long-range plan. She stressed that her dividend has never been more important than the services provided by state government. She noted that it takes more than money to live in Alaska. KEVIN RITCHIE, EXECUTIVE DIRECTOR, ALASKA MUNICIPAL LEAGUE testified in support of a balanced approach to state revenues. He observed that development of a state long-range fiscal plan is the top priority of the Alaska Municipal League. Municipal governments are state governments. The state and municipalities jointly provide education, public safety and road services. The Alaska Municipal League supports a balanced approach to revenues such as HB 411. Mr. Ritchie stressed the need to look at taxes and revenues. He pointed out that over the last 10 years there has been a $200 million dollar increase in property taxes collected in the state of Alaska. The total amount of revenue collected from property tax is $450 million dollars. Money collected from property taxes has almost doubled in the last 10 years. At the same time, revenue sharing has been reduced by $100 million dollars over the past 10 years. He spoke in support of a municipal dividend. He pointed out that the tax cap initiative is the result of increased property taxes. A municipal divided would extend benefits of the Permanent Fund to the people and stabilize local taxes. Vice Chair Bunde maintained that there would not be a tax cap initiative if local municipalities had reduced their spending instead of increasing taxes. Mr. Ritchie observed that two-thirds of the revenue collected through property tax goes to education. Municipalities also provide road service, fire and police services. He observed that the public is asking for better road maintenance, more police officers and better schools. Representative J. Davies noted that there is a call for less state spending but more state services. Mr. Ritchie did not feel that state expenditures could be reduced sufficiently to cover the fiscal gap. An income tax that would balance the budget would be too high. A sales tax that could cover the gap would have to be 20 percent. There has to be a balanced approach. He personally supports HB 411 as a balanced approach. PAM LABOLLE, PRESIDENT, ALASKA STATE CHAMBER OF COMMERCE testified in support of a long-range fiscal plan. She applauded efforts to continue discussions. The Alaska State Chamber of Commerce laid out their support for three elements: reduction in the size and spending of state government, some use of the Permanent Fund earnings and, if necessary, a broad-based tax. The organization had not met to discuss support for the specific plan outlined in HB 411. However, the bill holds the three elements proposed by the Alaska State Chamber of Commerce. Vice Chair Bunde pointed out that the plan is a prototype not a finished product. In response to comments by Representative Phillips, Ms. LaBolle stated that the Alaska Chamber of Commerce would be happy to be involved in continued work on the issue. BILL CORBUS, JUNEAU testified in support of a long-range fiscal plan and HB 411. The state must strive to get its financial house in order. The legislation is a good start and adopts the endowment concept, satisfies the dividend test, and recognizes the need for other sources of revenue. Representative Foster asked how to sell the plan to the public. Mr. Corbus responded that a media campaign was a mistake. He stressed the need to involve service organizations. Representative Phillips commented that she received phone calls that were organized by folks that lead the "no" vote campaign in September. The calls disagreed with one of the cuts made to the operating budget. She noted that her new slogan is: What part of "cut the budget" do you want me to ignore? People fail to understand that the vote represented only 84 percent of less than 25 percent of the voters of the state of Alaska. She stressed the need to let everyone in the state understand the issue. Representative J. Davies felt that the [September 14, 1999 advisory] vote was worthwhile but noted that he expected a "no" vote. He stressed that anyone would answer "no" to paying taxes or receiving less in their dividends. He emphasized that elected officials are elected to balance the desire to not pay any more taxes than necessary against the desire to have real services supported by state government. He maintained that such votes by the people always result in a "no" vote. He stressed that "the buck stops here" and that legislators were elected to make decisions. Legislators are in the best position to understand the balance between revenues and expenditures. He added that there were a large number of reasons why people voted "no". There was no one reason for the "no" vote. He concluded that legislators have the most information at hand and are best situated to make decisions. Representative Moses spoke in support of the legislation. He expressed disappointment that the issue was not resolved in the current session. He stated in his 1992 campaign that an income tax was needed. He maintained that there are large numbers of people in the state that want to create a nest egg and do not care what happens to the state in the future. He observed that he introduced legislation creating a municipal dividend and an income tax. He stressed that his oath of office was taken to do the best thing for the state of Alaska as well as for his district. HB 411 was heard and HELD in Committee for further consideration.