JOINT HOUSE & SENATE FINANCE COMMITTEE November 14, 1995 1:15 P.M. TAPE HFC 95-121, Side 1, #000 - end. TAPE HFC 95-121, Side 2, #000 - end. TAPE HFC 95-122, Side 1, #000 - end. CALL TO ORDER Co-Chair Mark Hanley called the joint House and Senate Finance Committee meeting to order at 1:15 p.m. PRESENT Co-Chair Hanley Co-Chair Frank Co-Chair Foster Co-Chair Halford Representative Brown Senator Donley Representative Grussendorf Senator R. Phillips Representative Kelly Representative Kohring Representative Martin Representative Mulder Representative Parnell Representative Therriault Senators Rieger, Sharp and Zarroff, and Representative Navarre were absent from the meeting. ALSO PRESENT Representative Bill Williams; Representative Jeannette James; Representative Ivan Ivan; Representative Jerry Sanders; Representative Betty Davis; Speaker Gail Phillips; Representative Ed Willis; Brian Rogers, Chairman, Long Range Financial Planning Commission (LRFPC); SUMMARY OVERVIEW: Long Range Financial Planning Commission Co-Chair Hanley observed that members of the Long Range Financial Planning Commission (LRFPC) consisted of: Brian Rogers, Chairman, Fairbanks; Judy Brady, Vice Chairman, Anchorage; Lee Gorsuch, Anchorage; Senator Georgianna Lincoln, Rampart; Robert Loescher, Juneau; Bruce Ludwig, Juneau; 1 Annalee McConnell, Juneau; Hugh Motley, Cooper Landing; Representative Mike Navarre, Kenai; Mary Nordale, Fairbanks; Mike O'Conner, Anchorage; Representative Sean Parnell, Anchorage; Pat Pourchot, Anchorage; Senator Steve Rieger, Anchorage; and Marie Westfall, Ketchikan. Members were provided with copies of the Commission's report (Attachment 1). BRIAN ROGERS, CHAIRMAN, LONG RANGE PLANNING COMMISSION summarized that the Commission was established in March 1995. The Commission consisted of 15 members: 5 members appointed by the Governor, 5 members by the Senate President, and 5 members by the Speaker of the House. The Commission issued a preliminary report in August 1995, detailing the size and growth of the State's fiscal gap, and options the Commission would consider. He added that the preliminary report contained four scenarios for reducing the State's budget by $500.0 million dollars. He summarized that the Commission examined the size of the fiscal gap, looked for budget reductions and revenue increases, examined the budget process, considered the relationship between the State and local governments in providing services, and recommended changes. Mr. Rogers noted that the Commission found that the fiscal gap for FY 96 is $524 million dollars. He observed that the gap equals all the salaries and benefits paid to state employees from the General Fund in FY 95. Mr. Rogers explained that the Commission developed a "base case" to show what would happen if there were no changes to the State's taxation picture or the level of services being provided. The Commission found that over 10 years the gap would widen to nearly $1.4 billion dollars. He pointed out that a flat dollar budget would result in a reduction in services. Mr. Rogers observed that the Commission identified funds which affect the fiscal gap and funds which do not affect the fiscal gap. He noted that general funds and general fund program receipts are funds which are available for use in closing the fiscal gap. He emphasized that the Constitutional Budget Reserve Fund, Permanent Fund earnings, some University of Alaska receipts and loan funds are all available in closing the gap. He added that funds created by an appropriation from the General Fund for a specific purpose can also be recaptured and used to close the gap. 2 He identified funds that are not available in closing the gap: federal funds, trust funds, retirement funds, transfers between agencies for contractual obligations (including interagency receipts), and certain holding accounts. Mr. Rogers emphasized that the Commission's plan was adopted by a super majority vote. He acknowledged that the Plan represents concessions from all the members of the Commission. He stressed that the Plan uses Permanent Fund income to replace declining oil revenues. He maintained that the Plan enhances the State's ability to save for future generations and increases the size of the Permanent Fund over time. He emphasized that the Plan imposes some spending discipline on the State. The State will have to curtail its spending over the next four years. He asserted that the Plan defines a role for the Permanent Fund and clears confusion regarding cash reserves. He summarized that the Plan suggests some structural changes in state government. He conceded that the Commission did not fully pursue the role of state and local government and their respective responsibilities. He asserted that the public was involved in the development of the Plan. He observed that the Plan requires two constitutional amendments: one affecting the Constitutional Budget Reserve Fund and the other affecting the Permanent Fund. Mr. Rogers stressed that the Commission's plan would balance revenues and expenditures in FY 2000 by: * Cutting spending; * Increasing revenues; * Establishing the Permanent Fund as an endowment; and * Capping the Permanent Fund dividend pool. In the first three years the Commission proposes to cut state spending by $100 million general fund dollars. State general fund expenditures would be reduced by: * $40 million dollars in FY 1996; * $30 million dollars in FY 1997; and * $30 million dollars in FY 1998. Mr. Rogers noted that when adjusted to include the effects of inflation these cuts represent a $300 million dollar or 5 percent reduction to services. He asserted that federal action over the next few years would prohibit greater budget reductions. He noted that the federal transfer of Medicaid to the Medigrant program could impose significant costs on the state of Alaska. In addition, changes are expected in other federal block grant programs. The Long Range 3 Financial Planning Commission recommends that another commission be established in a few years, after federal changes have been implemented, to determine if: other spending cuts are recommended, additional taxes should be implemented, or an income tax should be reinstated. Mr. Rogers noted that the Commission did not make specific recommendations for cuts. He outlined the Commission's general recommendations for areas savings can be achieved: * Enact a retirement incentive program for public employees, and school districts and municipalities that wish to participate; * Enact a new Tier II retirement plan to be implemented for new public employees entering after the adoption of the Plan (Retirement benefits would be lowered for new employees); * Implement new geographic pay differentials for non-covered state employees: * Study geographic costs differentials in Alaska for use during collective bargaining negotiations with covered employees; * Compare salaries and benefits of public employees to appropriate public and private markets in Alaska and the Pacific Northwest; * Look at consolidation of administrative support functions between state agencies; * Look at consolidation of state departments; and * Look for methods to reduce the growth of formula programs with a focus on education and health and social services. (The Commission recommends that new formulas be adopted.) Mr. Rogers noted that the Department of Corrections is the fastest growing state department. The Department of Corrections has grown 604 percent over the last 17 years. Population when factored with inflation grew 150 percent. The Commission counseled that health plans for the State, school districts, municipalities, the University of Alaska, and the Medicaid program be reviewed for opportunities to increase the amount of self insurance. Mr. Rogers acknowledged that the Commission did not reach a consensus regarding the Longevity Bonus Program. He stated that the Commission counsels that the program be discontinued if the Court rejects the Legislature's plan to 4 phase out the Longevity Bonus Program. Mr. Rogers reviewed the Commission's recommendations regarding local governments: * Reappeal the Senior Citizen' Tax Exemption and allow for a local option; * Shift inspection functions to local governments when possible; * Eliminate state support for trooper road patrols in communities of more than 2,500, but allow communities to continue to retain such services if they are willing to pay for them; and * Look for opportunities to contract out for state services. Mr. Rogers summarized that per capita spending would be significantly reduced over a 5 year period. General Fund spending would decline slightly over a four year period. Mr. Rogers examined the Commission's recommendations to raise $150.0 million dollars in new taxes and user fees: * Increase tobacco taxes to a dollar per pack on cigarettes and enact comparable taxes on other tobacco products; (Mr. Rogers estimated that an additional $1.00 dollar tax would raise approximately $43.0 million dollars. He emphasized that studies show that price increases would lower youth consumption.) * Increase taxes on alcohol to an average of .10 cents a drink; * Increase the Marine Motor Fuel Tax to .08 cents a gallon; * Increase the Highway Motor Fuel Tax to .22 cents a gallon; (The Commission further recommends that this tax be used to address deferred maintenance costs.) * Double motor vehicle license fees and eliminate exemptions in the second year of the Plan; and * Increase taxes on fisheries and other resources by $30.0 million dollars. 5 Mr. Rogers stressed that the Commission's recommendations, if implemented, would result in stable revenues through the year 2002. The Commission recommends that a state income tax be implemented in the year 2002. He emphasized that the Permanent Fund would be the corner stone of the Plan. The Permanent Fund would be established as an endowment with a payout rate of 4 percent of the market value of the proceeding five years. He explained that the constitutional dedication of mineral lease revenues, royalties and bonuses to the Permanent Fund would be raised from the current 25 percent to 50 percent for all fields. This would take $250.0 million dollars out of the annual revenue stream and place it into the Permanent Fund. The Commission recommends depositing the entire Earning Reserve Fund into the principal of the Permanent Fund. In addition, the Commission advises that everything over $1.5 billion dollars in the Constitutional Budget Reserve Fund be added to the Permanent Fund. He noted that the intent is to strengthen the Permanent Fund. Oil revenues will not be completely replaced by revenue from the Permanent Fund. He noted that if ANWR is approved additional revenues would be realized. Mr. Rogers recounted the Commission's recommendations for the Permanent Fund Dividend Program: * The dividend pool be dropped by $50.0 million dollars for the next three years. The payment level would then be held steady. * Permanent Fund dividend payments would be $900.0 in 1997; $800 in 1998; and $700 every year thereafter. Mr. Rogers summarized that the Plan would result in a deficit for three years and be balanced in the fourth year. He noted that a state income tax would have to be reinstated to prevent a deficit which would start in the fifth or sixth year. The endowment plan would increase the Permanent Fund by one-third over 10 years. He observed that the Commission recommends that the sweep provision of the Constitutional Budget Reserve Fund be repealed and that use of the Fund be triggered by majority vote based on a decline in revenues instead of expenditures. He noted that $1.5 billion dollars, which would remain in the Constitutional Budget Reserve Fund, is approximately equal to one year's oil revenues. The Commission recommends annual reports and program reviews be completed to determine if each program is needed, cost effective, and achieves the result it is intended to achieve. 6 Mr. Rogers summarized that the Plan: * Makes the Permanent Fund the corner stone of Alaska's future; * Closes the fiscal gap by the year 2000; * Ensures the growth of the Permanent Fund, to offset declining oil revenues; * Stabilizes and diversifies revenues; * Controls state general fund spending; * Maintains the Constitutional Budget Reserve Fund as a reserve; and * Decreases dependence on oil revenues. Mr. Rogers observed that the Department of Revenue projects that inaction would result in the depletion of the Constitutional Budget Reserve Fund by August 31, 2000. Senator R. Phillips asked if the Commission advocated the dedication of any taxes to special funds. Mr. Rogers stated that the Commission did not reach a consensus on that issue. Representative Martin spoke in support of user fees. He noted that the Commission did not strongly support user fees. Mr. Rogers stated that the report acknowledged the role of user fees. Senator Halford questioned if the Commission reviewed supplementals. (Tape Change, HFC 95-121, Side 2) Co-Chair Hanley stated that he had not seen a plan to cut the eduction foundation formula. He acknowledged that it will be difficult to cut education funding. He observed that there is not much interest by public employees to see a reduction to state employee salaries. He emphasized that it is less difficult to tax tobacco. He stressed that the hardest task will be to change what is currently given or provided to people, as opposed to what would be taken from the people in the future through new taxes or benefits. Mr. Rogers noted that the Commission had the luxury to vote the Plan up or down with a single vote. He observed that there are people that would rather raise taxes than cut 7 spending, and people that would rather cut spending than raise taxes, but both were willing to except a package that included both. In response to a question by Co-Chair Hanley, Mr. Rogers stated that the Commission has a time-frame for the aggregate dollar amount of reductions in state spending. He added that he believed the Commission would have been more specific as to spending reductions if there had been more time. He noted that the sooner a reduction in spending occurs the greater the impact will be. He discussed the implementation of a Tier II retirement system as an example of a spending side reduction. LEE GORSUCH, COMMISSION MEMBER, ANCHORAGE observed that if the Commission's recommendations on the Constitutional Budget Reserve Fund were enacted then the Legislature would be forced to tax or cut spending because all the other money would be off the table and put into the Permanent Fund. Senator Halford questioned, if there is a $500 million dollar gap, how much of the solution is in terms of new dollars and how much of the solution is in terms of reallocating existing dollars. Mr. Rogers explained that the percentage changes overtime. In the fourth year, $100 million nominal dollars and $300.0 million real dollars would be taken out of the spending side. He further explained that the fiscal gap would be filled by cutting 100.0 million dollars from the budget; raising $150 million dollars in new revenues; placing $250 million dollars in existing revenues into the Permanent Fund. Mr. Gorsuch summarized that there would be $150 million dollars out of new taxation and $250 million net increase in money coming from the Permanent Fund, plus a $100 million dollar reduction from state spending. Senator Halford concluded that the majority of the money would be achieved by a reallocation from what is currently in the private sector. He argued that the size of the pie is not changing. He acknowledged that income and tourism taxes would be true increases. Mr. Rogers estimated that the total state economy is approximately $14.0 billion dollars with a $500.0 million dollar hole to fill. He noted that an income tax would bring in approximately $200.0 million dollars. Non-resident workers who are working in Alaska would contribute approximately $25.0 million of the $200.0 million dollars. He estimated that the State would net another 20.0 million dollars as a result of the deduction by Alaskan residents of 8 their state income tax from their federal income tax. Mr. Rogers noted that the Commission rejected the institution of a sales tax. He explained that sale taxes have traditionally been used to provide local government support. He stated that there was strong support on the Commission for a seasonal sales tax. He stressed that most economic development, other than oil, does not bring in additional revenues, absent an income or sales tax. He observed that economic development which increases the number of state residents, increases the State's cost. Further oil development would bring more new dollars into the State. He observed that the Oil and Gas Policy Council is expected to have recommendations for encouraging oil development. Senator Donley asked how much more time the Commission would need to comply with the mandate to identify further spending reductions. Mr. Rogers noted that the Commission's preliminary report outlined four scenarios that reached the $500.0 million dollar reduction level. The majority of the Commission felt that the $500.0 million dollar reduction level was not realistic or appropriate. He stressed that the scenarios for reduction contained in the interim report do not provide for the level of services that Alaskans desire. Representative Therriault referred to the concept of forward funding. He questioned why the Commission did not pursue a stable long range revenue stream. Mr. Rogers replied that the Commission was unable to find a scenario that allowed the Cremo Plan to work. He noted that the Cremo plan works well from the year 2005 and on. He stressed that the level of budget reductions and additional taxes needed to implement a complete endowment plan was not supportable. He asserted that the Plan could reach a complete endowment if another oil field comparable to Prudhoe Bay were discovered. He emphasized that based on current revenues and the level of budget reductions the Commission felt are feasible that the fiscal gap could not be made up until the year 2005. Representative Mulder observed that the House Finance Committee Subcommittee on the Department of Corrections is looking into the possibility of privatization within the correctional industry. Mr. Rogers acknowledged that privatization of the correction industry would be consistent with the recommendations of the Commission. Representative Martin stressed that formula programs represent the biggest increase to the budget. He asked if the public testified in favor of maintaining or increasing the level of service provided by the State. He maintained 9 that Alaska provides residents with a level of service which is above the national norm. Mr. Rogers explained that his comments were based on a budget reduction of $500.0 million dollars. He concluded that the scenarios that reached the $500.0 million dollar level quickly entailed more political pain than the public is willing to accept, in the short run. He agreed that formula programs are the most difficult area of the budget to contain. He praised the Legislature for maintaining the cost of formula programs in nominal dollars over the past five years. Representative Parnell noted that the Plan brings revenues in line with current state spending. He suggested that spending needs to be brought into line with current state revenues. He questioned where the Commission would turn after the recommended new revenues are implemented. Mr. Rogers suggested that a new commission be implemented after three years, prior to implementation of an income tax to assess the level of spending and services that the public wishes to maintain. Senator R. Phillips asked if the Commission had complied a list of services provided by the state of Alaska that are not provided in other states. Mr. Rogers noted that the Permanent Fund Dividend and Longevity Bonus Programs are the biggest two services not provided by other states. He noted that the Hickel Economic Summit compared services to other states. He noted that almost every state has some form of sharing with local governments. In response to a question by Representative Kelly, Mr. Rogers noted that out of a $157 million dollar decrease in expenditures that $75 million is due to inflation, $30.0 million is due to spending reductions, and $50 million from a cut to Permanent Fund dividends. Representative Brown asked Mr. Rogers to reflect on the plan proposed by Dave Rose, former Alaska Permanent Fund Corporation executive director. She noted that Mr. Rose's plan would transfer unrealized gains of the Permanent Fund to the Constitutional Budget Reserve Fund. The Constitutional Budget Reserve Fund would be reformed into an endowment. Mr. Rogers expressed concerns that the Rose plan would only fill half of the gap in the early years and less in later years. He pointed out that the process of taking unrealized gains would require the sell of the entire stock portfolio. He noted that the Constitutional Budget Reserve Fund would not provide a break on spending. Representative Brown asked if Mr. Rogers is confident that the current principal of the Permanent Fund will never be spent. He stated that he is confident that the current 10 principal would not be spent. He observed that a 4 percent spending level would lessen the risk of reaching the principal. He pointed out that today's principal would be increased through appropriation of revenues into the Permanent Fund. Mr. Gorsuch added that the Commission was concerned with the use of realized earnings, as opposed to the use of market value, for accounting purposes. Representative Brown summarized that "unrealized earnings could end up outside the principal if they were realized." Mr. Rogers agreed that they would flow into the Earnings Reserve Account into the newly designated Constitutional Budget Reserve Fund that could be invested. In response to a question by Senator Halford, Mr. Rogers explained that the total rate of return including dividends would be 4 percent. He maintained that pressure to reduce dividends would increase. Senator Halford summarized that for every $100 million dollars taken out of Permanent Fund dividends, $12 million dollars would be take from the poor and $5.0 million would be taken from retirees and senior citizens. He questioned if the Commission "could have found a more regressive way to generate the money". Co-Chair Hanley stated that he agreed with the Commission's approach to address the dividend program before reinstituting an income tax. He stated that "it doesn't make sense to take money from the private sector to pay for the common good of people before we take money that is being paid from the common good (Permanent Fund) to pay for the common expenditures." He observed the lack of a connection between people's pocketbooks and state spending. He suggested that the "minute we have an income tax while we still pay out dividends to every one, it is a social scheme for redistribution of income rather than the other way around." He acknowledged that there are differences of opinion on the issue, even within parties. Mr. Rogers pointed out that the Plan is a compromise of both view points. Representative Mulder observed that one of the Plan's conclusions was to bring state salaries in line with comparable private sector positions. He observed that the State is currently negotiating new contracts. He asked if it would be a logical conclusion to assume that the Commission would find that the Legislature should reject the contracts. Mr. Rogers stated that it would not be a logical conclusion. He emphasized the need to compare salaries and 11 market preference. He estimated that a true look to market would raise salaries for some and lower salaries for others. He estimated that there is more salary compression in state government than in the private sector. He felt that the net effect would be to lower the cost to the State. He stressed that the Commission is not recommending an across the board approach. He did not think a market evaluation could be completed in time to make a decision on the current contracts. He suggested that an evaluation be funded to arm the Legislature for future negotiations. Senator Donely referred to the assumption that the Permanent Fund endowment would grow by 4 percent. He questioned if a 4 percent estimate is conservative. Mr. Rogers stated that a national study of approximately 400 university endowments shows that the range of endowment growth has been between 4 and 6 percent. The norm has dropped from 5 percent to 4.6 percent. Senator Donley noted that the Cremo plan was based on a 6 percent growth rate. Mr. Rogers asserted that 6 percent is not sustainable. Senator Donley noted that the Cremo plan assumed new revenues of $400.0 million dollars would be created immediately. Mr. Rogers asserted that if the gap is filled all at once that there would be a negative economic impact on businesses and individuals around the State. He maintained that by closing the gap slowly over four years the natural growth in the economy should even out. He stressed that a sudden $500.0 million dollar reduction would result in a recession. Representative Donley questioned if the political incentive to insulate the corpus of the Permanent Fund will be removed by capping dividends. (Tape Change, HFC 95-122, Side 1) Mr. Rogers stated that the Commission could not reach a majority in support of a growing dividend. Mr. Gorsuch maintained that the public will remain concerned since the level of state services will be tied to the health of the Fund. He maintained that eviscerating the Medicaid program and cutting back on day assistance for welfare recipients are extremely regressive measures. He added that cutting back on school support is regarded as harmful to children. He summarized that some members supported a reduction of dividends as a trade-off to prevent a greater reduction of services to those that are least able to provide for themselves. In response to a question by Senator Frank, Mr. Rogers stated that the Commission discussed the likelihood that the Plan would be politically acceptable. He stressed that the likely alternative is to allow the economy to crash. He 12 acknowledged that the public may not have a clear understanding that an economic crash is the alternative to action. Senator Halford asked who would fund the campaign to adopt the Plan if it were put on the ballot. Mr. Rogers estimated that there is strong support for some plan within the business community due to the stability a plan would provide. Senator Halford observed that the recession which occurred in the mid 1980's was the result of a reduction in the total size of the economic pie in the state of Alaska. He asserted that the Commission is proposing a reallocation of service within the existing pie. He summarized the effect to the economy will not be as detrimental as those experienced in the mid 1980's. Mr. Rogers agreed that the situation is different than in the mid 1980's. He added that the natural growth of Alaska's economy will mask the economic dislocation and that there should not be a huge negative impact. He noted that an income tax, sales tax or employment tax would bring in outside dollars to the state of Alaska. He observed that 15 percent of the dividend cut would come from the federal treasury. Senator Halford maintained if funding is taken from the dividend pool and put into the general category of state spending, more would be lost in federal income tax because of the percentage of payroll. Mr. Rogers agreed with Senator Halford's conclusion. In response to a question by Representative Therriault, Mr. Rogers reiterated that approximately 10 percent of an income tax would be derived from non-residents. Senator Halford observed that the ratio of tax paid by non-residents could be changed by allowing exemptions for local property tax and other credits. Representative Martin pointed out that a lot of jobs taken by out-of-state workers are less desireable. He suggested that the Governor can take $20.0 million dollars out of the budget by not taking a supplemental. He added that $16.0 million could be take out of capital projects improvements, $23.0 million out of debt service, and $29.0 million dollars out of the Permanent Fund Dividend Hold Harmless Program. Representative Martin asked if the Commission studied level of services in relationship to population growth. He asserted that school population has grown by 14 percent over the past ten years. The school budget increased by 33 percent in ten years. Mr. Rogers noted that the Commission studied a 17 year period. He stated that, over the seventeen year period the Commission studied, the growth in 13 population with inflation was 166 percent. School funding increased by 175 percent during the same period. He noted that grants to individuals grew by 500 percent and correction funding grew by 600 percent. Senator Donley observed that a Legislative Finance Division report on the Cremo Plan stated that the Cremo Plan assumes that the dividend program would be eliminated or a reduction in state spending equal to the dividend program would be made. He noted that the Long Range Financial Planning Commission Plan would not make as big a reduction in state spending and the dividend program would be continued. Mr. Rogers agreed that there is a significant dollar difference between the two plans in the years 1997 & 1998. He stressed that the Cremo Plan would be ideal once the optimum level is reached. He stressed that if there is another windfall payment to the State that the Cremo Plan would be attractive. Co-Chair Hanley noted that the real rate of withdraw for the Cremo Plan would be less than 6 percent since all of the State's oil revenue would be deposited in the principal of the Fund every year. He stressed that the real rate of reduction would be 3 to 4.5 percent. He pointed out that there is only a certain amount of money to be spent. He observed that under the Commission's plan the state of Alaska would still be spending more money than revenue until a balance is reached. He emphasized that actual dollars start growing again after FY 99. By the year 2005 the budget would be up to $3.3 billion dollars. By the year 2010 there would be a $136.0 million dollar fiscal gap. He pointed out that the Commission's plan assumes that state government has to grow at a certain rate, not that the State has to live within revenue projections. He noted that the Cremo endowment, once the transition period is passed, spins off a greater increase, which would allow for more growth over time. He noted that without further measures, the Long Range Financial Planning Commission Plan would result in growing deficits of $400 - $500 million dollars. Mr. Rogers observed that the addition of unforseen new revenues would make the years 2005 and on more attractive. Representative Brown commented that a Department of Labor study estimates the non-resident work-force to be 25 percent. Mr. Rogers explained that estimations were based on the Department of Revenue's 1980 income tax figures. Senator Halford acknowledged the Commission's efforts in defining the problem and recommending solutions. Mr. Rogers urged members to give a little more on issues in order to achieve a compromise that will appeal to a majority. He 14 stressed that any plan that survives needs to be bi- partisan. ADJOURNMENT The meeting adjourned at 3:30 p.m. 15