HJR 7-CONST. AM: PERM FUND & PFDS HB 73-PERM FUND; ADVISORY VOTE 3:53:29 PM CHAIR KREISS-TOMKINS announced that the next order of business would be HOUSE JOINT RESOLUTION NO. 7 Proposing amendments to the Constitution of the State of Alaska relating to the Alaska permanent fund, appropriations from the permanent fund, and the permanent fund dividend and HOUSE BILL NO. 73 "An Act relating to use of income of the Alaska permanent fund; relating to the amount of the permanent fund dividend; relating to the duties of the commissioner of revenue; relating to an advisory vote on the permanent fund; providing for an effective date by repealing the effective date of sec. 8, ch. 16, SLA 2018; and providing for an effective date." 3:54:03 PM BRIAN BREFCZYNSKI, Office of the Governor, relayed that securing Alaska's fiscal future was the governor's top priority for the state and its residents. The first step towards achieving that goal, he said, was to protect the Alaska Permanent Fund and ensure the continuation of the Permanent Fund Dividend (PFD) for future generations of Alaskans. He pointed out that after years of Constitutional Budget Reserve (CBR) and Statutory Budget Reserve (SBR) spending, the Earnings Reserve Account (ERA) and its potential depletion was a topic of discussion. He said the governor recognized the risks associated with that conversation and offered this legislation in response. HB 73 would establish a statutory framework to protect the permanent fund and provide for a sustainable annual draw; further, of the amount available for appropriation, fifty percent would be designated for dividends. He conveyed the governor's belief that the will of the people must be included in this decision; therefore, the proposed constitutional resolution [HJR 7] would require a vote of the people. It would also require that any future change to the dividend formula be approved by the voters. HB 73 would further provide that a statewide election be held to take an advisory vote on whether the statutory changes proposed in the bill were favorable. In closing, he emphasized the governor's desire for the public to be involved in this process of protecting the permanent fund and the dividend. 3:57:20 PM MIKE BARNHILL, Deputy Commissioner, Department of Revenue, introduced a PowerPoint presentation, titled "HJR 7: Amending Constitution re Permanent Fund; HB 73: statutory 50/50 PFD Formula" [hard copy included in the committee packet]. He began on slide 3, which outlined the objectives of HJR 7: protect the permanent fund; constitutionally protect the PFD; adopt a one account structure; preserve the ERA balance; and engage Alaskans. To protect the fund [first bullet point], he discussed aligning the permanent fund with a traditional endowment fund by implementing management practices that would protect the inflation adjusted value forever, thus balancing the needs of both present and future generations and protecting intergenerational equity. In regard to constitutionally protecting the PFD [second bullet point], the resolution required that a portion of funds withdrawn from the permanent fund would be used for a dividend. He noted that the legislature would control how much of the allocation went towards the PFD. Adopting a one account structure [third bullet point] would be more efficient from an investment perspective, he said, and exhaustion of the fund's income account, the ERA, would be avoided [fourth bullet point]. He explained that for a number of years, the permanent fund's trustees had expressed concern about potentially depleting the ERA. The amount of distribution from the permanent fund for both the dividend and the government spending had increased year over year, which heightened the risk of prematurely exhausting the ERA. He reiterated that transitioning to a one-account structure would eliminate that risk. He reported that engaging Alaskans [fifth bullet point] addressed the governor's desire to constitutionalize the public's role in approving any changes to PFD allocations. 4:01:49 PM REPRESENTATIVE CLAMAN considered a scenario in which the legislature approved a change to the dividend formula under this proposal, but the voters did not approve the constitutional change. He asked whether the formula change would take effect. MR. BARNHILL believed that a formula change by the legislature would be effective regardless of whether the constitutional measure was enacted. He explained that an advisory vote did not have legal implications and that a statutory change was still the legislature's responsibility. REPRESENTATIVE CLAMAN asked whether the advisory vote would be required if the constitutional amendment did get the necessary two-thirds vote in the legislature or was rejected by the voters. MR. BARNHILL said it would not be required; however, he noted that the advisory vote was a provision in HB 73, so it would be required if the bill were to pass. 4:03:58 PM CHAIR KREISS-TOMKINS pointed out that slide 3 summarized several points of agreement, including the notion that ad hoc draws were bad; a one-account structure was better than the current two- account structure; and to protect the permanent fund forever for future generations of Alaskans. He asked whether the administration was of the same opinions. MR. BARNHILL confirmed and expressed appreciation for the chair's acknowledgement. He believed that there were more shared opinions than points of contention, adding that the administration put forward these proposals in an effort to find maximum consensus. 4:05:20 PM REPRESENTATIVE EASTMAN questioned what "the time of adoption" on page 3, line 8, of HJR 7 referred to. MR. BARNHILL explained that the constitutional measure required a two-thirds vote by each body of the legislature. It would then be on the ballot for approval by voters at the next general election - the earliest being November 2022. If it were to pass by a majority vote, the measure would take effect 90 days from the date of the election. He further noted that Representative Eastman was referring to transitional language in Section 3 of HJR 7, which would apply to the FY 24 budget. 4:07:20 PM BILL MILKS, Assistant Attorney General, Department of Law, directed Representative Eastman to Section 1 of [Article XIII] in the Constitution of the State of Alaska, which specified that a new amendment becomes effective 30 days after certification of the election returns. REPRESENTATIVE EASTMAN sought verification that an amendment was "adopted" 30 days after the election certification. MR. MILKS believed it would be reasonable to interpret that an amendment would be adopted when it becomes effective. REPRESENTATIVE EASTMAN proposed a scenario in which "the legislature were to pass a law ... after the vote but before the amendment [was] effective." He asked whether the amendment would "tie back to" the newly passed legislation or the legislation passed prior to the public vote. MR. MILKS clarified that the only public vote that was legally effective was the vote on a constitutional amendment. He pointed out that HB 73 had a provision pertaining to an advisory vote, which would not create law. MR. BARNHILL resumed the presentation on slide 4, which reviewed the mechanics of HJR 7. He explained that the proposed resolution would transition the permanent fund to a single, protected account. It would also add the percent of market value (POMV) distribution method to the constitution. He noted that in 2018, the legislature statutorily enacted a POMV formula in Senate Bill 26, which applied the distribution percentage to a lagging five-year market average of the permanent fund. He defined a "lagging five-year average" as the first five of the last six years. Further, under this proposal the legislature would be responsible for specifying a distribution percentage; the legislature would also have the authority to fix that distribution percentage by statute. He added that ultimately, enshrining that percentage in a constitutional measure could be accomplished at the legislature's discretion. He conveyed that HJR 7 would establish the PFD in the constitution by specifying that a percentage of the POMV distribution must be allocated to the dividend. He reiterated that the governor was proposing to leave the specification of that percentage to the legislature to enact by statute. Alternatively, in HB 73, the governor proposed that the legislature enact a 50 percent allocation to the PFD. He further noted that the proposed resolution [HJR 7] would require a vote of the people to approve any change to the PFD program. 4:12:35 PM CHAIR KREISS-TOMKINS questioned whether DOL was of the opinion that with passage of HJR 7 as written, the statutory formula, whatever it may be, shall be appropriated and supersede the legislature's "subjective desires for appropriation." MR. BARNHILL deferred to Mr. Milks. MR. MILKS remarked that as drafted, HJR 7 specified that a portion of the appropriation from the permanent fund shall be allocated for the PFD. Further, Section 2, subsection (c), stated that the amount allocated for the dividend shall be provided by law. CHAIR KREISS-TOMKINS said he understood the language in the proposed resolution. He asserted that he was looking for a direct answer to a direct question: whether DOL was of the opinion that the formula was constitutionally guaranteed and effectively superseded the legislature's constitutional right to appropriate an amount other than the formula. MR. MILKS said, "that is what HJR 7 provides in Section 2." CHAIR KREISS-TOMKINS asked for confirmation that Mr. Milks and DOL believed that "that is what would happen constitutionally." MR. MILKS replied that's how HJR 7 was drafted. He suggested that it was consistent with Wielechowski v. State of Alaska, in which the court decided that without a constitutional amendment, the PFD amount would be decided by the legislature. CHAIR KREISS-TOMKINS asserted that he had not heard a direct answer to his question. He pointed out that the language in the proposed resolution was not as specific as a constitutional amendment that were to provide for the dividend formula. He asked if the broader language in HJR 7 would constitutionally guarantee whatever formula was in statute, thus superseding the legislature's constitutional right to appropriation. MR. MILKS answered yes, this constitutional [resolution] (indisc.) the dividend and shall provide for a portion of the amount to the dividend. 4:17:12 PM REPRESENTATIVE VANCE, referring to the language "as provided by law" in Section 2, subsection (c), asked whether that provision would be satisfied "if the legislature chose to come up with a number as an appropriation." MR. MILKS explained that "by law" referred to a statute, not a law that was enacted as an appropriation bill, as specified in Section 3, subsection (d), of HJR 7. 4:18:45 PM MR. BARNHILL continued the presentation on [slide 5] and outlined considerations for a distribution percentage in regard to HJR 7. He relayed that the permanent fund was "manually" inflation proofed through an annual appropriation from the ERA to the Principal, which was calculated by a statutory formula. However, in a modern one-account structure, such as an endowment, the inflation proofing would occur through a distribution percentage. Slide 5 read as follows [original punctuation provided]: • Legislature establishes the distribution percentage in statute -POMV is currently 5% of the lagging 5-year average market value • Limits spending while allowing the fund to grow to keep up with inflation • Spend only the real return over time. -Example: square4 Total return: 7% square4 Inflation: 2% square4 Real return: 5% • Liming spending to 5% inflation-proofs the Permanent Fund. MR. BARNHILL explained that the real return was calculated by subtracting annual inflation from total return. In modern institutional fund practice, inflation proofing was accomplished by only spending the real return while retaining the inflation return, thus preserving the growth associated with inflation. He emphasized that inflation could change over time and returns could be volatile. He reported that the permanent fund's real return and spending rate varied over time; however, for most years, the spending rate was less than the real return, which indicated growth. He noted that in HJR 7, the governor proposed that the distribution percentage could be statutorily adjusted by the legislature to prevent overspending from the fund. He pointed out that the inherent flexibility in HJR 7 was similar to HJR 1, which used the phrased "not more than 5 percent." That language would allow the legislature to monitor the rate of spending versus the rate of return and prevent the fund from erosion by inflation, he said. 4:23:50 PM REPRESENTATIVE TARR, returning to Section 2, subsection (c), inquired about the timing in which the legislature was relayed the total return and inflation rates. She understood that those rates were assessments of economic conditions that were typically received "after the fact." MR. BARNHILL indicated that there was an established practice of using the lagging five-year market average; consequently, when entering a budget cycle, it was clear what the formula was proposing with respect to spending. He suggested that the lagging five-year rolling return could be used to determine whether it was under or over the spending level. He added that his overarching recommendation was to keep an eye on things by reporting these figures annually. REPRESENTATIVE TARR observed that a reporting requirement, which was absent from the current language, could which be a friendly inclusion to strengthen the proposal. MR. BARNHILL acknowledged that it could be included in statute. He noted that the effective rate of spending had been presented to the House Special Committee on Ways and Means. He maintained that he was discussing these figures to emphasize to policy makers that this was the method to avoid eroding the fund by inflation. 4:26:59 PM REPRESENTATIVE VANCE asked why five percent was the appropriate POMV rate for the fund's long-term sustainability. MR. BARNHILL conveyed that the governor proposed 5 percent as a starting place with an expectation of continued discussion. He explained that 5 percent was standard in the world of endowments, institutional funds, and foundations. He noted that in foundations, 5 percent was hardwired into the internal revenue code to maintain tax exempt status. He understood that 5 percent was raising some anxiety because there was concern that the current bull market would settle, and it could be harder to accomplish a real return of 5 percent. He assured members that 5 percent was currently sound and that investments had been "phenomenal" this year. REPRESENTATIVE VANCE inquired about 5 percent in relation to the tax-exempt status. MR. BARNHILL clarified that he did not intend to imply that the permanent fund was subject to the internal revenue code laws on foundations. He explained that the permanent fund was tax exempt on the grounds of being a state fund. He noted that there had been three opinions rendered by outside counsel in the past 30 years, all of which had affirmed that tax exempt status. 4:30:47 PM CHAIR KREISS-TOMKINS inquired about policy calls that could jeopardize the permanent fund's tax-exempt status. MR. BARNHILL offered to follow up with the requested information. He recalled that the last opinion, which was rendered in 2003 by the law firm of Steptoe & Johnson, indicated that the permanent fund would be tax exempt as long as it was managed as a state fund. CHAIR KREISS-TOMKINS asked whether the administration would be opposed to a lower POMV draw of 4.5 percent in statute or in the constitution. He relayed that a more restrictive draw would MR. BARNHILL declined to comment on behalf of the administration. He recommended treating the present and the future as equally as possible. Therefore, by growing the fund at the rate of inflation, today's beneficiaries would have the same access to the fund as the beneficiaries of tomorrow. He emphasized that the the notion of intergenerational equity was important to endowments and cautioned against anything that would "hardwire" underspending of the fund to save for the future. 4:34:46 PM MR. MILKS, in response to a question from Representative Eastman, said the process proposed in HJR 7 would provide for one way in which the permanent fund distribution could be changed: a law passed by the legislature that was then affirmed by a majority of voters. REPRESENTATIVE EASTMAN clarified that he was asking about calculating the amount for the dividend amount and whether that could be passed through a ballot measure. MR. MILKS explained that [subsection (b)] in Section 2 of HJR 7 would set a POMV draw from the permanent fund, as provided by law; subsection (c) of Section 2 specified that a portion of that amount would be allocated for dividend payments, as provided by law; subsection (d) of Section 2 further specified that changing the amount allocated for dividend payments would require a law passed by the legislature that must then be approved by voters. He summarized that the proposed resolution offered a unique process to change the allocation regarding dividends involving legislation then confirmation by voters. REPRESENTATIVE EASTMAN stated that his constituents periodically suggested "[taking] the permanent fund and ... [paying] it out to Alaskans and be done with the whole permanent fund and dividends, etcetera." He asked if this resolution were to pass, how that idea could be achieved. MR. MILKS said that concept would still require a constitutional amendment if HJR was adopted. 4:38:10 PM REPRESENTATIVE EASTMAN considered a scenario in which 32 legislators voted to set the percentage at 100 percent and designated the entirety to dividends. He questioned what would stop that situation from happening. MR. MILKS acknowledged the resolution provided that an amount of the POMV may be appropriated and that the POMV would be set by law. Additionally, it would require that an amount of that sum be paid in dividends, as provided by law. He reiterated that a change would require the voters' approval. MR. BARNHILL in response to Representative Eastman, pointed out that the constitution utilized the word "permanent," which must mean something, he said. Secondly, he touched on the emerging concept of prudent spending, noting that Representative Eastman's suggestion would fall into the realm of imprudent spending. He resumed the presentation on [slides 6] and explained that HB 73 would implement HJR 7 by setting the statutory POMV at 5 percent and the statutory PFD allocation at 50 percent. The bill would also schedule an advisory vote on the PFD formula to be held 90-120 days after adjournment. He noted that HB 73 would stand on its own without the passage of HJR 7. 4:41:56 PM REPRESENTATIVE VANCE returned to subsection (b) in Section 2 of HJR 7, which stated that "the legislature may appropriate from the permanent fund to the general fund an amount as provided by law". She asked what would occur if the legislature chose not to appropriate from the permanent fund to the general fund, as subsection (c) specified that there "shall" be an allocation for dividends. MR. BARNHILL deferred to Mr. Milks. Nonetheless, he questioned whether the legislature would ever find themselves in that scenario. MR. MILKS acknowledged that page 2, line 1, states that the legislature "may" appropriate from the permanent fund while line 6 states that a portion "shall" be appropriated for dividend. He concluded that if any money came from the permanent fund, a portion shall be allocated for dividends. CHAIR KREISS-TOMKINS understood that despite the unlikely scenario, the administration had confirmed that it would be an elective decision. MR. BREFCYNSKI said despite the wording, it was not the governor's intent that the dividend would be elective. He added that the administration was fully prepared to engage in conversations about amending that language if necessary. 4:44:56 PM REPRESENTATIVE VANCE requested a fiscal model of the fund's potential growth under this proposal to understand its economic impact. MR. BARNHILL said he would be happy to prepare that for the committee. 4:45:55 PM CHAIR KREISS-TOMKINS announced that HJR 7 and HB 73 were held over.