HOUSE JOINT RESOLUTION NO. 2 Proposing amendments to the Constitution of the State of Alaska relating to an appropriation limit. HOUSE BILL NO. 38 "An Act relating to an appropriation limit; relating to the budget responsibilities of the governor; and providing for an effective date." 10:07:20 AM Representative Hannan asked Co-Chair Foster to restate the amendment deadline for the bills. Co-Chair Foster relayed the information. ALEXEI PAINTER, DIRECTOR, LEGISLATIVE FINANCE DIVISION, provided a PowerPoint presentation titled "HB 38 and HJR 2 Appropriation Limits," dated May 8, 2023 (copy on file). He began on slide 2 showing the current constitutional appropriation limit. He explained that there were two parts to an appropriation limit: appropriations subject to the limit and the limit itself. Mr. Painter moved to slide 3 and addressed appropriations subject to the current constitutional limit. He noted that exceptions to the limit included certain fund sources and purposes. He explained that not all general fund appropriations were subject to the current limit. Exclusions included Alaska Permanent Fund Dividends (PFDs), appropriations of revenue bond proceeds, appropriations required to pay the principal and interest on general obligation bonds (i.e., any bond debt repayment was excluded from the limit), and appropriations of money received from a non-state source in trust for a specific purpose, including revenues of a public enterprise or public corporation of the state that issues revenue bonds. Mr. Painter detailed that the limitation included federal funds held in trusts for a specific purpose, statutory designated program receipts where an outside group initiated a contract with the state, revenues of a public enterprise or public corporations (e.g., Alaska Housing Finance Corporation), and no appropriation in excess of the limit could be made except to meet a state of disaster declared by the governor. Additionally, the legislature could exceed the limit for appropriations to the Permanent Fund (special appropriations to the Permanent Fund fell outside the limit). He relayed an attorney general's opinion [from 1983] indicated that school debt reimbursement was excluded from the limit. He noted it was municipal debt, not state debt, but the opinion ruled it fell under the debt provision; therefore, it was excluded from the limit. He explained that when the limit was calculated by the Legislative Finance Division (LFD) and officially by the Division of Finance it factored in the exclusions of fund sources and certain types of expenditures. 10:11:59 AM Mr. Painter reviewed a pie chart on slide 4 showing appropriations subject to current constitutional limit, FY 23 management plan. The purple portion of the chart reflected appropriations subject to the limit at about $5.8 billion. The yellow section reflected PFDs including the energy relief payment at about $2.1 billion. Bond proceeds accounted for a small portion of the chart [at approximately $73.6 million. Appropriations from a non- state source reflected the majority of the appropriations [at $8.9 billion]. He explained that nearly half of the state's appropriations were federal and the segment also included public corporations, international airports, and so forth. 10:12:55 AM Mr. Painter turned to slide 5 and discussed the starting point and growth rate of the current constitutional limit. The current limit applied to $2.5 billion as adjusted by the cumulative change derived from federal indices, population, and inflation since 1981. He stated there was a little ambiguity on how to calculate the current constitutional limit. He detailed that the Division of Finance under the Department of Administration made the official calculation by multiplying inflation and population. For example, if there was a 2 percent growth in inflation and population, the limit would be multiplied by 1.02 twice. He pointed out that the Municipality of Anchorage had a tax cap with identical wording, but its calculation was added. For example, if the two numbers were 2 percent and 3 percent, the two numbers were added together to equal 5 percent growth. He explained it was a difference of about $3 billion compounded over 40 years. He advised making the calculation very clear when designing a limit. He noted that the current calculation was not clear, and LFD viewed the language as ambiguous. The official calculation resulted in a limit of about $11.3 billion in FY 23. Representative Galvin referred to Mr. Painter's statement that the Municipality of Anchorage used a different calculation resulting in a $3 billion difference [compounded over 40 years]. She asked whether the $11.3 billion [under the current constitutional limit] would be higher or lower based on the different calculation method. Mr. Painter responded that the other calculation would be about $3 billion lower. Representative Galvin asked if the number would be at $8.3 billion. Mr. Painter replied that it was in the $8 billion to $9 billion range versus the $11 billion to $12 billion range. Mr. Painter turned to slide 6 and reviewed a bar chart showing the constitutional appropriation limit since its inception [in FY 83]. The blue bar reflected agency operations, which tended to be the steadiest item. The green portion of the bars reflected statewide operations and the red portion reflected the capital budget. He highlighted that current numbers showed that the state broke the limit in the first few years. He explained that at the time, many language appropriations were not counted in the way they would be counted at present. He elaborated that under modern accounting the limit had been broken in the first few years, but under contemporary accounting, spending had been within the limit. Following the first several years there was a prolonged period of budgets that did not grow quickly or keep up with inflation, which caused a substantial difference between the appropriation limit and the budget. When the state had significantly more revenue, expenditures spiked and approached the limit, but did not reach it. At present, under more constrained revenue, appropriations were a bit more than $5 billion beneath the constitutional limit. Co-Chair Edgmon noted the slide was not new: there had been many iterations before and would be more in the future. He thought population growth in the state should be included on the slide because much of the state's operating budget was population driven. He cited Medicaid as an example. He noted that the current proposal did not have a direct link to population, but he believed it should. He elaborated that the state's population was getting older. He asked about the impact of population on overall state spending. Mr. Painter answered that the slide adjusted for population and inflation. He stated that population would influence the number of students in schools and the number of Medicaid recipients. He expounded that many of the large budget drivers were driven by the size and composition of the state's population. He explained that an aging population meant fewer students in schools. He relayed the state had seen roughly the same number of students in its schools for about 25 years despite an increase in population during the same period. He elaborated that more people utilized social services as the population aged. The population had grown and shifted where expenditures occurred in the budget. He added that an aging population did not necessarily mean there were lower expenditures, in some cases, some departments were much higher. He suggested that one interesting way to view the graph was to adjust for inflation and population and show the black line [reflecting the constitutional appropriation limit] as flat, while showing how expenditures had fluctuated in real terms rather than showing how the line had fluctuated. He explained it may appear the state had increased the budget substantially, but inflation and population had increased far more than the budget. Co-Chair Edgmon remarked that Alaska paid for more state services than any other state in the country based on the state's constitution. He remarked there was not a cascading layer of taxes at the county level. He noted Alaska did not have counties. He believed population had to be a driver in any spending cap going forward. 10:19:25 AM Representative Hannan asked if the definition of statewide operations had been changed in the FY 07/FY 08 timeframe. She asked why there had been a large jump at the time, which seemed to be fairly steady proportionally. Mr. Painter answered it had been driven by two things. The first was statewide assist retirement. He elaborated that there had not been a known unfunded liability until FY 03. The liability was $700 million per year by FY 13. The second [reason for the increase in statewide operations] was oil and gas tax credits. He explained that there were a couple of bills in the 2000s that created tax credits that were no longer on the books that the state was still paying off. He noted the expenditure was several hundred million dollars per year. The two items accounted for most of the increase in statewide items. Additionally, during that time there had been the creation of new state funds including the Higher Education Fund and increasing the Power Cost Equalization (PCE) Fund. He explained that new funds often showed up as a statewide item, although any further appropriations would be outside the limit and would not necessarily show up on the chart [on slide 6]. 10:21:02 AM Representative Stapp could not think of any example where population growth did not positively impact gross domestic product (GDP) output. He noted that the same was true for population decline. He asked if the assessment was fair. Mr. Painter answered that it was true to some extent; however, because the state's economy was driven by resource extraction, its GDP fluctuations were due to the prices and quantity of resources being extracted. He stated it was possible to look at statistics for the oil industry, timber, fisheries, and mining. He explained that taking out minerals including oil and gas, the numbers were much more stable and reflective of overall economic growth. The fluctuations in value of the state's exports drove much of the year-to-year fluctuations. The fluctuations were not directly tied to population, although when oil prices crashed, there was less activity on the North Slope and the state's population decreased. There was a relationship [between population growth and GDP], but it was not as direct as in many other states because of the large value of Alaska's natural resources. Co-Chair Edgmon relayed that he viewed the topic a bit differently because 70 percent of the state's population resided within the Railbelt. He remarked that the GDP was an academic term that fluctuated given one-time events that may have no impact on the cost of living in 30 percent of the state population, which lived off the road system. He opined that population, being directly involved in the spending cap, had a better tie-in to cost of living or the ability for the state to provide the equal amount of services in rural areas compared to urban areas. He remarked that GDP numbers were very different and impacted the state in different areas. He thought the GDP calculation was abstract in many respects and did not reflect the actual cost of providing services in outlying areas. Representative Galvin looked at the black line on slide 6 and asked if it reflected the current constitutional appropriation limit. Mr. Painter replied, "If we spent to the limit every year, yes." Representative Galvin noted that the state had clearly not spent to the spending limit. She highlighted there had been substantial inflationary costs in 2021 and 2022, yet there had not been a rise in appropriations. She stressed that regardless of population size, the state still had to deliver certain public services whether there were three people or 33 people needing the service. She remarked that the price of oil and diesel had increased substantially. She thought they were seeing an explanation as to why schools and other public services had been flatlined and legislators were frustrated to see there was not sufficient money to spend on wages and healthcare benefits. She presumed the money just had not been there. She asked for verification that the chart did not include the PFD. Mr. Painter confirmed that the PFD was not included as an expenditure subject to the limit; therefore, it was not included in the chart. Representative Galvin opined that if the PFD was one of the largest expenditures, it should be included as part of the equation. She asked Mr. Painter to comment on the "sky high" inflation in 2021 and 2022, yet no increase was seen on the graph [on slide 6]. She thought it indicated there had been no money to deliver services or the state had decided to make sure the PFD was large enough. She asked what it would look like if the PFD was included in the discussion. 10:26:45 AM Mr. Painter replied that there were a couple of slides later on in the presentation showing the PFD under the proposed legislation. There was a substantial increase in spending in FY 23, but there was a drop in FY 22 because spending had largely followed available revenue. Representative Galvin asked if some of it was related to federal COVID-19 pass through funding. Alternatively, she wondered if the slide only included state funding. Mr. Painter replied that all federal funds were excluded because they were held in trust for a particular purpose. The one exception was using American Rescue Plan Act (ARPA) revenue replacement, which spent the same as undesignated general fund (UGF). 10:27:51 AM Mr. Painter turned to slide 7 and discussed the capital budget exclusion in the current constitutional limit. The current limit specified that at least one-third was to be reserved for capital projects and loan appropriations. He relayed that the language was sometimes interpreted to mean that one-third of the budget should be capital and two- thirds should be operation. He explained that it was not really how the language read. He clarified that the language meant that within the limit at least one-third was to be reserved for capital projects. He returned to slide 6 and explained that of the [constitutional appropriation limit of] $11.3 billion, one-third may be for capital and two-thirds may be for operating. He stated that essentially, there was a separate limit for the operating budget that was two-thirds of the overall limit, and the capital budget could be any amount, but up to one-third was reserved for that purpose. He explained that the language essentially was setting a lower limit for the operating budget. There were also provisions allowing the legislature to exceed the capital project appropriation limit if passed in a similar manner to a general obligation bond bill. He elaborated that because general obligation bond debt was excluded, the limit specified that if the money was available, the issue could be sent to the voters for approval, which would enable the state to exceed the limit. Representative Hannan asked if there were any years where the budgets had been two-thirds operating and one-third capital. Mr. Painter answered there had not been a year where one- third of the budget went to capital funds during the current appropriation limit. He noted there were a couple of years (e.g., 2014) where the operating budget exceeded the two-thirds. In the early years of the limit there was an attorney general opinion ruling that during years of constrained revenue, the funds should not necessarily go towards the capital budget. He did not know if FY 08 would qualify as a year of constrained revenue, but it was a year the two-thirds limit had been violated. 10:30:56 AM Representative Josephson asked if a lawsuit would have been viable in the two years mentioned by Mr. Painter. Mr. Painter answered that the state likely did violate the two-thirds limit, but no one had challenged it at the time. He stated that the timing of the constitutional appropriation limit meant that any challenge would have to be made after the fiscal year closed and the expenditures had been made. He explained it was a bit of a challenge to determine what the consequences would be if a lawsuit was filed. He believed it was something the current bills and others tried to address by making it possible to calculate the limit ahead of time. He explained that under the current constitutional limit, a violation was not known ahead of time. He elaborated that after the fact someone could have challenged what the legislature had done; however, at the time the limit had been breached he was not sure there had been awareness they were in danger of going over the limit. Mr. Painter turned to slide 8 and addressed the current statutory appropriation limit, which was established a few years after the constitutional appropriation limit. He relayed it was based on appropriations made in a fiscal year rather than for a fiscal year (supplementals were counted in the year appropriated, not the year they were effective). He pointed to the previous session as an example of why the current statutory appropriation limit existed. The current statutory limit, limited spending growth to population plus inflation plus 5 percent. He stated it seemed very high. Mr. Painter highlighted that in 2022, there was 8 percent inflation plus 5 percent and around zero population growth for a total of 13 percent growth. There was also a large spike in revenue (far more than 13 percent) in the same year and the legislature grew spending by 56 percent of UGF. The current statutory limit specified that the legislature could only spend up to 13 percent of the revenue spike. He stated it was not designed to be a path for the legislature to follow and he thought the LFD graphs were perhaps misleading because they were shown as path. He explained that in reality it was a year-to-year limit indicating to the legislature that it could only spend up "x percent" more than it had the previous year regardless of the size of a spike in revenue. He relayed that the limit had been broken repeatedly, which was allowable because the legislature's constitutional power of appropriation trumped the statute. The statutory limit allowed the legislature to move things freely across supplementals and non-supplementals. He highlighted that in 2022 there were a number of capital projects that had a supplemental effective date because "that was when revenue was available"; however, the funding did not particularly apply to that given year. 10:34:28 AM Mr. Painter turned to a graph on slide 9 showing the current statutory appropriation limit. The graph showed the legislature had broken the statutory appropriation limit "quite often" and by a substantial amount in FY 22 (applying to FY 22 and FY 23 appropriations made in the last session). The limit had been violated by a bit in FY 18 and FY 20 and in quite a few years as the budget was growing through FY 12. The intention of the statute was to lop off spikes when a spike in revenue occurred. Representative Hannan stated that wildfires tended to be a large supplemental expenditure. She stated that one good policy model was to put more money into the wildfire operation upfront to avoid always backfilling with funding. She asked what would make the most sense within the current statutory appropriation limit. She asked if the legislature should exclude wildfire and supplemental because of its unpredictability from the calculation. Mr. Painter responded it would fall under the state of disaster. He explained that the way the limits worked did not really give the best incentives. He detailed that the governor generally only declared the disaster when money was needed beyond what had already been appropriated. He furthered that if the legislature appropriated zero, everything would be a state of disaster, or the legislature could appropriate more upfront and there would not be a state of disaster. He stated that under the statutory limit when there was growth from year-to-year it was perhaps not as big of a concern as long as there was a relatively stable budget and any disaster funding that had not been counted did not perhaps cause issues. The constitutional model with a fixed point could not be gamed by zeroing it out. He remarked that on a scale of billions of dollars, the amount was relatively small and was not a huge lever. He stated it was perhaps a little questionable as currently written and perhaps there could be clarification to ensure the legislature did not have the incentive to underfund wildfires to get under the limit. 10:37:23 AM Mr. Painter read from slide 10 titled "HB 38 and HJR 2": • Uses similar appropriations included and excluded as current limits • Sets limit as percentage of private sector GDP for both constitutional and statutory limits current CS is 11% for HB 38 and 13% for HJR 2 • Each percentage in the limit equals $475 million of spending in FY24 Mr. Painter elaborated on the third bullet point above and indicated that in future years the amount would vary as GDP grew. 10:38:14 AM Mr. Painter turned to a graph on slide 11 reflecting the versions of HB 38 and HJR 2. The bars reflected the appropriations subject to the limit, the shaded areas in the background reflected revenue, the blue line reflected the proposed statutory limit [HB 38], the red line represented the proposed constitutional limit [HJR 2], and the black line reflected the current constitutional limit. FY 24 was indicated with a black vertical line, followed by projections for future years. The slide used 11 percent and 13 percent of GDP, which reflected the current bill versions. He relayed that the next few slides would show different versions of the bill and the inclusion of the PFD as requested by the committee. Representative Josephson looked at the projected growth in GDP. He believed it was inarguable that operating budgets contributed to GDP. He asked if it was realistic the growth identified on the graph [on slide 11] would occur if downward pressure was put on operating budgets. Mr. Painter answered that projecting GDP was very difficult and there was not an official Alaska GDP estimate or projection. He explained that the Department of Labor and Workforce Development or any other institution did not have a responsibility to make a projection. He explained that LFD was making up the 1.5 percent [GDP growth] number. The number was based on historical averages, and he was not comfortable speculating what influenced GDP because there was no official projection in the state. Representative Josephson considered a scenario where there was population growth toward the beginning of the next decade. He elaborated on a scenario where the state would need more teachers, but could not hire them; therefore, the teachers could not afford to buy homes. He asked if the scenario would impact GDP. Mr. Painter confirmed that any fiscal policy choice would impact GDP. 10:41:10 AM Mr. Painter turned to slide 12 showing the original version of the bills, which included 11.5 percent of GDP for the statutory appropriation limit and 14 percent of GDP for the constitutional appropriation limit. He relayed the .5 percent difference was about $237 million and the 1 percent difference was about $475 million respectively. The graph showed that in FY 24 the original version of the bill, the statutory appropriation limit was a bit closer to the current budget as proposed by the House. The previous limit was substantially under the House budget. Representative Galvin asked about operating versus capital and how Alaska had behaved as a state historically. She remarked that it felt like the lines had been pretty muddy. She elaborated that she saw many things in the operating budget that she could imagine being called capital and vice versa. She asked Mr. Painter to comment on the topic. She asked if the bills would result in more "jockeying around" in order to make things add up in the right place. Mr. Painter answered there were legal definitions for the difference between operating and capital. He stated that generally when appropriation bills were drafted the legislature was stricter about trying to put operating items in the capital budget because the capital budget had a longer lapse timeframe. Whereas the legislature was a little less strict on putting capital items into the operating budget because with only one year to spend the money it was a disadvantage. There was some muddying because the legislature retained the power of appropriation, and could put things in whatever bill it wanted and call them whatever it wanted despite the opinions of LFD and Legislative Legal Services. He stated that LFD would often give guidance on which budget it believed items belonged. He did not believe there would be any difference in how operating and capital were treated in the bills. He was not sure there would be an incentive to try to muddy the waters. He stated that under the current limit there were some exclusions for capital projects, but only if approval could be obtained from voters, which was a fairly high bar. He was not sure whether that was retained in HJR 2. Representative Galvin remarked that Mr. Painter had stated there was currently a bit of muddying occurring, but it was based on what the legislature had chosen to do. She asked if the parameters [in the bills] added more clarity and transparency or less. Mr. Painter did not know that the bill would necessarily change what the legislature would choose to call a capital or operating item. Generally, the legislature tried to follow the statute that set out what qualified as a capital project and what qualified for the capital lapse provisions that were more favorable. 10:45:07 AM Representative Josephson asked if the budget passed in 2022 would have required a two-thirds vote from both chambers to exceed the cap on capital budgets in light of generous Infrastructure Investment and Jobs Act (IIJA) funding. Mr. Painter replied that the federal appropriations were outside of the limit, but match would be included. He relayed that the FY 23 operating budget exceeded the limit contemplated under the original [bill] version; therefore, it would have required an additional vote. Representative Josephson asked if members from both chambers (frequently minority members) could leverage their vote in exchange for additional capital dollars, which would grow the capital budget. Mr. Painter replied that it was similar to the dynamic with the Constitutional Budget Reserve (CBR) where people could use it for leverage and often that leverage was additional spending rather than reduced spending. He relayed that any higher vote threshold could be leveraged for more spending. Representative Josephson remarked that even though it may sound like cronyism or crass politics, it had a rationality as well. He stated that human behavior suggested that sort of thing could happen. He asked if his statement was fair. Mr. Painter replied it was more political territory than he wanted to weigh in on. 10:47:23 AM Mr. Painter turned to a graph on slide 13 showing the Senate version of the bills SB 20 and SJR 4 that had been amended upwards to 12 percent and 15 percent of GDP respectively. The numbers had been selected because they were in line with the governor's FY 24 budget (the numbers were slightly different than current House budget). Mr. Painter moved to slide 14 titled "HB 38 and HJR 2 Current CS with Statutory PFD (11% and 13% of GDP)." The purple section of the bars reflected the addition of the statutory PFD. He reminded committee members that the PFD was excluded from the current limit and the current bills. He noted that LFD had been asked to show how the PFD compared to the appropriations under the limit. Representative Hannan asked for verification that because the PFD was excluded from the current constitutional limit, LFD had not included it in the operating monies. She asked for verification that the operating budget portion of the bars did not include the PFD that had not been paid, even in the years that did not include a statutory [PFD]. Mr. Painter answered that the historical numbers reflected what had been paid and the statutory [PFD] was reflected in the projections going forward. He pointed to FY 23 and FY 24 and clarified that the bars reflected the PFD that had been distributed and not what the statutory number had been in those years. Representative Hannan asked if Mr. Painter had stated that the slide reflected the payment of full statutory PFDs even in years the full amount had not been paid. Mr. Painter answered that the slide showed the amount actually paid for all years, whether the statute had been followed or not. Mr. Painter turned to slide 15 titled "HB 38 and HJR 2 Current CS with 50/50 PFD (11% and 13% of GDP)." The graph reflected the PFD at 50 percent of the percent of market value (POMV) going forward, which was the amount included in the House budget. He noted the PFD shown in the historical bars reflected the actual amount paid. 10:50:16 AM Mr. Painter turned to slide 16 titled "HB 38 and HJR 2 Current CS with 75/25 PFD (11% and 13% of GDP)." The slide showed the 75/25 where 25 percent of the POMV draw went to the PFD as contemplated current Senate budget. Co-Chair Edgmon stated that it was obvious that under the proposed spending cap something would have to give, whether it was the PFD, spending and operating, or capital budgets, in order to meet the spending cap threshold or trigger a supermajority vote. Mr. Painter confirmed that as currently written, the spending cap would be significantly below the current version of the House budget. He explained that meeting the 11 percent [of GDP under HB 38] would require reducing the budget to meet the number or changing the number in the bill (as done in the Senate version of the bill). Co-Chair Edgmon stated it would also speak to the 11.5 percent and 14 percent of GDP [modeled on slide 12] and the 12 and 15 percent of GDP [modeled on slide 13]. He remarked that all of the modeling presumed a spending cap as proposed would mean something would have to give down the road whether on the budget side or PFD side. Mr. Painter answered that because the PFD was not included in the limit, the 12 to 15 percent of GDP would be close to expected spending assuming spending was fairly flat going forward, but a lower number would require spending reductions. Co-Chair Edgmon stated it was the reason the bills gave him pause because currently the way the bills were written would mean reductions would be on the social services side in the capital and operating budgets. He believed the legislature needed to take a hard look at the issue. 10:52:36 AM Representative Stapp looked at slide 13 showing the graph using 12 and 15 percent of GDP [under SB 20 and SBR 4 respectively]. He asked for verification that the spend under the proposed statutory limit [SB 20] included the capital budget as well. Mr. Painter responded affirmatively. Co-Chair Foster reviewed the schedule for the afternoon.