SENATE BILL NO. 199 "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; and providing for an effective date." 9:33:33 AM Co-Chair Bishop relayed that it was the third hearing for SB 199, and the committee would consider fiscal modelling scenarios presented by the Legislative Finance Division (LFD). 9:33:52 AM AT EASE 9:34:15 AM RECONVENED ALEXEI PAINTER, DIRECTOR, LEGISLATIVE FINANCE DIVISION, discussed the presentation "Fiscal Modeling: Senate Finance Committee Scenarios; Senate Finance Committee, April 20, 2022; Legislative Finance Division" (copy on file). He advanced to slide 2, "Outline": ?Review of LFD Modeling Baseline Assumptions ?Comparison of Senate Finance Committee Assumptions to LFD Baseline ?Fiscal Models Using Committee Assumptions Mr. Painter detailed that the comparison of committee assumptions was different than the previous time he presented in order to reflect changes in the budget since that time. 9:35:00 AM Mr. Painter spoke to slide 3, "Review of LFD Modeling Baseline": ? Legislative Finance's fiscal model is designed to show policy makers the longer-term impact of fiscal policy decisions. ? The baseline assumptions are essentially that current budget levels are maintained, adjusted for inflation. Policy changes are then applied against that baseline. ? Our default is to assume that statutory formulas will be followed. This includes a statutory PFD beginning FY23. Mr. Painter referenced slide 4, "Review of LFD Modeling Baseline (cont.)": Revenue Assumptions ? LFD's baseline revenue assumptions are the Department of Revenue's Spring Revenue Forecast. This assumes $101 oil in FY23, following futures market thereafter. DNR oil production forecast projects that Alaska North Slope production will increase from 502.3 thousand barrels per day in FY23 to 576.6 thousand barrels per day in FY31. ? For the Permanent Fund, we use Callan's return assumption of 5.86% total return in FY22 and 6.20% thereafter. Mr. Painter noted that the spring forecast was about a month old and the current futures market was very close to the spring forecast with a little flattening. He considered the spring forecast to be appropriate for use in the modelling. Mr. Painter turned to slide 5, "Review of LFD Modeling Baseline (cont.)": Spending Assumptions ? For agency operations, these scenarios assume the Governor's FY23 amended budget grows with inflation (2.25%). ? For statewide items, the baseline assumes that all items are funded to their statutory levels beyond FY23. This includes School Debt Reimbursement, the REAA Fund, Community Assistance, oil and gas tax credits. ? For the capital budget, we assume the Governor's FY23 capital budget grows with inflation (2.25%) ? For supplementals we assume $50.0 million per year. This is based on the average amount of supplemental appropriations minus lapsing funds each year. ? For the PFD, we assume a statutory dividend is paid annually beginning FY23. Mr. Painter considered slide 6, "LFD Modeling Baseline," which showed two bar graphs entitled 'UGF Budget/Revenue' and 'Budget Reserves; FY-ending Balance.' He mentioned that at the top there was a line showing the surplus/deficit in millions starting with FY 22 going to FY 31. The black numbers indicated surpluses in FY 22 through FY 24, and projected deficits from FY 26 and beyond. He highlighted that the graph on the left showed budget and revenue, with revenue shown in blue bars for traditional revenue from petroleum and non-petroleum sources and green bars for the percent of market value (POMV) draws. The other colors signified other draws from various savings accounts, most notably in yellow there was the Constitutional budget Reserve (CBR) and Statutory Budget Reserve (SBR), the states main savings accounts. Mr. Painter explained that the graph on the right showed savings accounts end-of-year balances, with the yellow showing combined CBR/SBR and the green showing the realized value of the Earnings Reserve Account (ERA). He summarized that the slide showed that with a statutory PFD that would pay about $4,200 per person in FY 23, there would be a surplus (based on the governors amended budget) of about $700 million, but by FY 25 there would be a deficit due to projected oil price declines. The deficit would start at about $300 million, changing to between $500 million and $800 million in subsequent years. Because of the surpluses in early years, savings accounts would grow by up to $5 billion by the first year, so even with deficits the state would not need ERA overdraws for the scenario. 9:39:11 AM Mr. Painter displayed slide 7, "Senate Finance Committee Scenarios": Committee Chair asked for modeling with the following assumptions that differ from LFD's baseline: ? Capital budget baseline of $400 million (instead of $195.4 million) ? All oil revenues resulting from ANS prices beyond $100/barrel deposited into Permanent Fund ? Agency operations assume FY23 SCS2 budget growing at 2.25%. ? Assume expiring federal funds are replaced with UGF and PERS healthcare is funded after FY23 ? Varying PFD scenarios: statutory PFD, 50% of POMV, and SB 199 with trigger passing and failing. ? Deficits are first filled with K-12 Forward Funding. CBR/SBR deficit draws only occur after the entirety of Forward Funding is used to fill deficits. Mr. Painter discussed the assumptions for the committees requested modelling scenarios. He noted that when looking at the probabilistic model, the surplus size flattened out a bit because at a certain point the surplus from high oil prices got deposited into the Permanent Fund, which depressed the top of the range. He mentioned a stress test scenario that had agency budget growth at 5 percent, which was roughly equal to the amount the Senate Committee Substitute (CS) grew versus the FY 22 budget. He noted that in the CS, the PERS healthcare funding for FY 23 was deposited into the Pension Fund, but the scenario assumed it would go into the Healthcare Fund in future years. Mr. Painter explained that the bill had a Permanent Fund Dividend (PFD) amount that would change based on a triggering mechanism that considered the presence of $800 million in new revenues enacted. He would show scenarios with the new revenue and without. Mr. Painter looked at slide 8, "SCS2 Budget": The SCS2 budget has significant changes from the Governor's amended budget, including: ? $60m FY22 supplemental appropriation to oil and gas tax credit fund. ? $1,215m for Forward-Funding K-12 in FY23. Modeling assumes this funding is reduced to fill deficits. ? Added $27m UGF to offset state agencies' increased fuel costs. ? Added $300m FY22 supplemental ARPA revenue replacement. Remaining $186m used in FY23. Mr. Painter detailed that one of the uses of American Rescue Plan Act (ARPA) funding was to replace lost Unrestricted General Fund (UGF) revenue. 9:44:06 AM Mr. Painter highlighted slide 9, "SCS2 Fiscal Summary," which showed a table. He noted that SB 199 would have a 50/50 dividend. He pointed out key figures on the table that left a roughly balanced budget: the ongoing pre- transfer surplus of $937 million in FY 22, and $43 million in FY 23. There was some use of savings that generated additional surplus, which in FY 22 resulted in $1.2 billion post-transfer surplus, and in FY 23 resulted in a bit over $200 million in surplus. He pointed out a combined total of about $3.5 billion for SBR and Constitutional Budget Reserve (CBR) balances. When added to the K-12 forward funding, there was close to $4.7 billion of liquid savings that could be used to fill future deficits. Mr. Painter addressed slide 10, "Comparison of Senate Finance - Scenario to LFD Baseline," which showed a table. He noted that the LFD baseline essentially represented the governor's budget growing with inflation. In FY 23, there was a $1.7 billion difference due in part to one-time K-12 forward funding. On an ongoing basis, the assumption difference was about $450 million of additional spending, with half in capital expenditures and half in operating expenditures. Senator von Imhof asked if the blue bars on the bar graph showed the governors budget and asked if the amount included all the different amendments that had been proposed in the previous four months. Mr. Painter answered in the affirmative and noted that the amount included the federal infrastructure bill and the amendments for recent salary adjustments. Mr. Painter advanced to slide 11, "Oil Prices, FY22 to Date," which showed a line graph entitled 'ANS West Coast Price.' He explained that the spring forecast had shown oil price at its peak, and it had been volatile since. Earlier in the year the prices were lower, with a ramp-up before the Russian invasion of Ukraine. He highlighted that when looking at the fiscal modelling scenarios, the spring forecast assumed that oil prices would return to the pre- war level within a few years. He noted that volatility scenarios would show oil price at significantly higher and lower ranges. 9:48:46 AM Senator von Imhof noted that the slide started showing the price of oil in July 2021 and thought if the graph been started two years prior it would have reflected greater volatility. She thought it was important to note that volatility in the price of oil was commonplace and mentioned the amount available to spend currently as compared to two years previously. Mr. Painter thought Senator von Imhof had made a good point. He noted that the price of oil had briefly been zero two years previously, and then touched $125/bbl. He thought when looking at scenarios and modelling, one could consider the extreme cases of volatility that had already occurred. Senator von Imhof asked to go back to slide 10. She looked at FY 23, and thought it was important to note that the committee proposed to fund several things that the governors budget had not, such as the Regional Educational Attendance Area (REAA) Fund, community assistance, and deferred maintenance. She thought the committee proposed to fund items that had not been funded for many years. Co-Chair Bishop answered "yes." He noted that there was also a supplemental included in the total. Mr. Painter stated that the supplemental was not included. He explained that the major difference in the lines on the graph was the K-12 forward funding of $1.2 billion. Much of the additional spending used UGF for the Alaska Marine Highway System (AMHS) and $400 million proposed for the capital budget. Senator von Imhof asked to confirm that the largest chunk of additional spending proposed by the committee was $1.2 billion for forward funding education. Mr. Painter looked at slide 12, "Stress Tests": ? Two types of stress tests performed: Budget stress test: grow agency operations and capital budget by 5% per year instead of 2.25% Revenue stress test: use probabilistic modeling to simulate a range of possible oil prices and investment returns ? For each PFD scenario, we will show the non- stressed model output and the two stress tests Mr. Painter discussed consideration of inflation rates. 9:52:56 AM Mr. Painter showed slide 13, "Stress Test: 25th Percentile Example": ? Example of a single case, for which 25% of total cases see greater overall deficits. ? Example case has average oil price of $77 and average Permanent Fund return of 7.0% Mr. Painter pointed out the volatility on the graph. He directed attention to the graph on the right entitled 'Permanent Fund Total Return,' and commented that even though there were decent years in later years, the value of the Permanent Fund was reduced. He thought the sequence of returns for the fund was quite important rather than just considering a straight average. He noted that oil volatility and the sequence of returns in the model were not favorable. He thought deterministic modelling could be misleadingly positive versus the actual impact of volatility in the real world. Mr. Painter referenced slide 14, "Statutory PFD - SFIN Baseline (2.25% Growth)," which showed two bar graphs. He explained that the scenario included the committee assumptions. He pointed out items on the bottom of the slide that indicated the cost of the PFD in the scenario and the amount per person. 9:56:24 AM CONNOR BELL, FISCAL ANALYST AND ECONOMIST, LEGISLATIVE FINANCE DIVISION (via teleconference), addressed slide 14. He explained that the slide depicted a scenario showing a statutory PFD with a 2.25 percent growth rate of agency operations and capital budget. The scenario included a deficit of $1.1 billion in FY 23, which was higher in the following years because of the $1.2 billion in K-12 forward funding discussed earlier. He highlighted the grey bar on the graph. The forward funding was shown as an expenditure, and later several hundred million of the funding amount was used to fill deficits in FY 23. He pointed out the brown portion of the bar that showed ARPA revenue replacement filling the first few hundred million of the $1.1 billion pre-transfer deficit. There were smaller deficits after FY 23, with deficits growing and then unplanned ERA draws beginning in FY 28. He pointed out that the graph on the right, 'Budget Reserves,' showed that the CBR hit the minimum balance of $500 million in FY 27, after which the unplanned ERA draws began. Mr. Bell turned to slide 15, "Statutory PFD - SFIN Baseline (5% Growth)," which showed an identical slide to slide 14, with the exception of 5 percent budget growth in agency operations and capital expenditure. He explained that the FY 23 budget was the same as the previous scenario, with the difference between the slides compounding over time. The deficits grew significantly, up to $2.2 billion by the end of the period. The K-12 forward funding reduction filled the FY 23 through part of the FY 25 deficits, after which the CBR and SBR were relied on until FY 27 when you could see ERA overdraws. The realized ERA balance fell to about $7 billion by FY 31 due to the sustained overdraws to the fund. Senator von Imhof thought slide 14 and slide 15 indicated that inflation had a significant impact on expenses and could not be ignored. She was reminded of the importance of inflation-proofing the Permanent Fund corpus. She thought the committee should consider inflation growth rates. She thought it was wise to model different inflation rates because it was material. 10:00:53 AM Mr. Bell considered slide 16, "Statutory PFD - Revenue Stress Test," which showed the statutory PFD in the probabilistic scenario. Mr. Painter addressed slide 16 and pointed out the median deficit each year shown on the top. The left-hand graph was on a previous slide. The blue bar in the middle represented the median scenario, the green bars represented the 25th and 75th percentile scenarios, and the black line represented the 10th and 90th percentile. He expected the vast majority of scenarios would fall within the lines. He pointed out that in FY 23 there was a bunching up where the median, the 90th percentile, and the 75th percentile were shown in the same place because the impact of the $100 per barrel draw into the Permanent Fund. Since the baseline forecast going forward was reduced, there was less compression in the graph. Mr. Painter addressed the graph on the right, which showed the range of fiscal year-end realized ERA balances. The bottom of the slide showed a table with CBR and SBR balance probabilities, which were below a certain amount. In FY 23, there was a 100 percent probability that the combined CBR and SBR values were below $4 billion, and by FY 31 there was a 90 percent probability. The other probability was that the CBR and SBR would be below $500 million. For the models, LFD assumed that there would be at least $500 million as a balance, so the scenarios had to overdraw the ERA. The scenario could also be interpreted as the probability of an ERA overdraw. In FY 23 the probability was fairly low at 21 percent, but the figure increased over time (as the revenue risk increased) to somewhere around 60 percent. 10:04:34 AM Mr. Bell displayed slide 17, "50% of POMV to PFD - SFIN Baseline (2.25% Growth)," which showed the same three scenarios except for the 50/50 PFD, which was half of the POMV draw from the Permanent Fund. The first graph showed a baseline of 2.25 percent annual growth for agency operations and capital expenditures. The FY 23 budget was roughly balanced. He noted that there was an assumption of $50 million in supplemental budget expense in FY 23, which would not show up in the fiscal summary. He noted that there was higher spending in FY 23, and FY 24 showed a significant surplus, which fell into deficits starting in FY 26. The forward-funding reduction was sufficient to cover the deficits through FY 28, after which began CBR and SBR draws in FY 29. There were no overdraws from the ERA in the scenario. He drew attention to the combined balance of CBR and SBR and realized ERA was over $20 billion by the end of the period. Senator Wilson commented that with the 50/50 PFD scenario, a low budget and modest revenues showed that the scenario could work. Co-Chair Bishop referenced the following slide. Mr. Bell highlighted slide 18, "50% of POMV to PFD - SFIN Baseline (5% Growth)," which showed a slide identical to slide 17 but for 5 percent in annual growth of agency operations and capital spending. He highlighted that the $12 million FY 23 deficit was the same, with a roughly balanced budget. The deficit started to grow based on the different compounding spending growth. He pointed out deficit growth up to over $1 billion by FY 28 and then up to $1.6 billion to $1.7 billion by the end of the period. Due to the significant reserves balance in the earlier period, the ERA was only overdrawn in the last two years of the scenario. He cited that the CBR/SBR and forward-funding reductions filled the deficits through FY 29. 10:08:03 AM Mr. Bell looked at slide 19, "50% of POMV to PFD - Revenue Stress Test," which showed two graphs: 'Surplus/(Deficit) by Fiscal Year,' and 'Range of FY-End Realized ERA Balances.' He cited that median surplus and deficit shown was similar to what was shown two slides previously, but the amounts differed in later years. He pointed out that on the lefthand graph the median and 75th percentile were roughly the same with the assumption that any oil price over $100/bbl would be deposited into the principal, which was only forecast for the first year. After FY 23, about 50 percent of the scenarios modelled showed between roughly $1 billion to $1.2 billion in deficits ranging to about $500 million to $1.5 billion in surpluses. The right-hand graph showed the median realized ERA balance slowly declining, with the ERA going to zero in the percentile. Mr. Bell noted that in the absence of any ERA overdraws, it was still possible for the account to draw towards zero as in the more negative scenarios, such successive low Permanent Fund returns, and other factors combined with a poor market. He explained that it did not require ERA overdraws for the ERA to draw down to zero. At the 75th percentile the scenario showed the realized ERA balance growing up to and beyond $30 billion. He pointed out that the bottom row of figures showed the CBR/SBR balance probabilities. 10:11:49 AM Mr. Bell addressed slide 20, "SB 199, Trigger Succeeds - SFIN Baseline (2.25% Growth)," which showed SB 199, first depicting three different models with the assumption that the bills trigger provision succeeded and $800 million in new revenue was instituted in FY 27. The funds would be added to the baseline revenue assumption for each year. Under the scenario the PFD would be 25 percent of the POMV draw until FY 27, after which the PFD would grow to 50 percent of the POMV. He noted that the bottom of the slide showed the PFD at $1600 per person in FY 27, growing to $3200 per person in FY 28 when there was a change in the PFD formula. There were surpluses throughout the period, with no need for ERA overdraws or use of the SBR and CBR. Senator Wilson considered the history of the legislature and the history of legislative spending in significant revenue years. He asked if LFD felt that the numbers would stay static. He wondered if there was a historical spending ratio that could be applied to the models. Mr. Painter thought the current year's budget could be used an example of what Senator Wilson was referencing; the growth was at 5 percent and the capital budget was growing significantly. He continued that starting in FY 05 and going through FY 14, the state operating budget had grown by an average of almost 8 percent per year. He acknowledged that the legislature had chosen to increase spending in times of greater revenue, which he emphasized was a policy choice that LFD could not predict. He added that there were still significant surpluses during the period, but spending also grew faster than inflation. Co-Chair Bishop made the point that some of the spending went towards the deferred maintenance backlog. He asked how much of the 8 percent went to deferred maintenance. Mr. Painter clarified that the eight percent increase was from the agency operations portion of the budget. He noted that some of the 8 percent of agency growth had gone into daily maintenance, but not necessarily into deferred maintenance. By FY 04, there had been about 15 years of flat or declining budgets. There was quite a bit of deferred growth. He noted that employee wages had not been increased in several years, and there was faster growth in contracts than previous years. He referenced pent-up demand for spending as a result of multiple years of flat budgets. 10:16:15 AM Co-Chair Stedman referenced the mention of salary and benefit increases in all three branches of government. He thought the committee had to make some decisions. He thought there was upward pressure. He commented on the previous flat inflation and the current inflation spike. He thought it was most likely that the inflation trend would continue for several years. He thought the slide showed an optimistically low rate of inflation. He thought the committee should take the inflations effect into account. Mr. Bell advanced to slide 21, "SB 199, Trigger Succeeds - Budget Stress Test (5% Growth)," explained that slide 21 was similar to the prior slide but for the 5 percent growth assumption in agency and capital spending. In the scenario, there were strong surpluses during the first several years, but beginning in FY 28 there were deficits. The deficits were filled by the K-12 forward-funding reduction for the first two years, after which the CBR and SBR filled the deficits. There were no ERA overdraws required and the ending CBR/SBR combined balance was about $8 billion at the end of the period. He noted that the PFD amount was depicted on the bottom on the slide and pointed out that it jumped up to 50 percent of the POMV in FY 28 like the prior slide. He noted that the orange bars on the graph on the left showed the $800 million in new annual revenue as part of the plan. 10:20:27 AM Mr. Bell showed slide 22, "SB 199, Trigger Succeeds - Revenue Stress Test," which included the $800 million in new revenue and the 25 percent POMV dividend that jumped to 50 percent in FY 28. With the probabilistic modeling, in FY 23 there was a range of a $1 billion deficit to an $800 million surplus. He pointed out that since any revenue over $100/bbl went to the Permanent Fund principal, the maximum surplus would be $830 million. The following three years showed a range of $2.5 billion to zero surplus. The jump-up in FY 27 was due to the institution of the first year of the $800 million in new revenue while the higher PFD had not started yet. Beginning in FY 28 there was a similar range of between $300 million to $500 million in deficits and $1.5 billion surpluses in half of the cases. The graph on the right showed that there were only ERA overdraws in about 1 percent or 2 percent of cases per given year. There was still some chance of the ERA going to zero if there were poor returns, but there was also a plausible likelihood of the ERA exceeding $30 billion. The assumptions also showed a high likelihood (about 93 percent) that the CBR/SBR combined total became greater than $4 billion in the later years. Mr. Bell spoke to slide 23, "SB 199, Trigger Fails - SFIN Baseline (2.25% Growth)," which modelled the bill effect assuming the trigger failed, no new revenue was instituted, and the PFD was 25 percent of the POMV for all years. He pointed out the PFD per-person amount at the bottom as $1,200 in FY 23, growing to about $1,700 per person in FY 31. There were surpluses shown throughout the period, with the 2.5 percent growth assumption. The combined reserve balances exceeded $30 billion by the end of the period, and there was no reserve draw required. 10:23:50 AM Mr. Bell discussed slide 24, "SB 199, Trigger Fails - Budget Stress Test (5% Growth)," which showed the same model as the previous slide but with 5 percent growth rather than 2.5 percent growth. He cited deficits starting in FY 28, with healthy reserves balances and about $100 million to $500 million in deficits per year. Senator von Imhof thought the previous two slides showed how inflation affected the long-term forecast. She thought it was important for the committee to consider at least a decade or two. She remarked on the compounding effect of inflation. She emphasized that she had a problem with taxing people in order to pay a dividend. She pointed out that SB 199 had a taxation component in order to pay a dividend. Mr. Bell showed slide 25, "SB 199, Trigger Fails - Revenue Stress Test," which showed a 25 percent POMV dividend for all years, with the probabilistic modelling. He noted that the median surplus and deficit was similar to three slides prior. The graph on the left, 'Surplus/(Deficit) by Fiscal Year' showed that in FY 23, one could see the deficit range from $1 billion to $800 million in surplus until FY 27. The range was similar throughout the period, with a balanced budget to a few hundred million in deficits ranging up to over $2 billion or more in surpluses in 50 percent of the cases in each year. There was only about a one or two percent chance of requiring ERA overdraws in the scenario. The chart on the right was similar to that of three slides previously since there were no ERA overdraws. 10:27:01 AM AT EASE 10:29:02 AM RECONVENED Co-Chair Bishop relayed that the amendment deadline for SB 199 was noon the following day. SB 199 was HEARD and HELD in committee for further consideration.