HOUSE FINANCE COMMITTEE SPECIAL SESSION May 22, 1999 7:20 P.M. TAPE HFC SS 99 - 1, Side 1. TAPE HFC SS 99 - 1, Side 2. TAPE HFC SS 99 - 2, Side 1. CALL TO ORDER Co-Chair Mulder called the House Finance Committee meeting to order at 7:20 P.M. PRESENT Co-Chair Mulder Representative Foster Co-Chair Therriault Representative Grussendorf Representative Austerman Representative Kohring Representative Bunde Representative G. Davis Representative J. Davies Representative Williams Representative Moses was not present for the meeting. ALSO PRESENT Phillip Okeson, Budget Analyst, Division of Legislative Finance; Gail Fenumiai, Election Program Specialist, Division of Elections; David Teal, Director, Division of Legislative Finance; Representative John Harris; House Speak Brain Porter. SUMMARY HB 1001 An Act authorizing an advisory vote on a long-term financial plan for the state; and providing for an effective date. HB 1001 was heard and HELD in Committee for further consideration. HOUSE BILL NO. 1001 An Act authorizing an advisory vote on a long-term financial plan for the state; and providing for an effective date. Co-Chair Mulder explained that the purpose of the meeting was to discuss the proposed HB 1001. He informed members that he had invited Phil Okeson, Legislative Finance Division, to address the proposed legislation and to provide a comparison of the legislation provided by the Senate Finance Committee. Representative Bunde asked what will happen if no plan is adopted. PHIL OKESON, BUDGET ANALYST, DIVISION OF LEGISLATIVE FINANCE, commented that if no plan is implemented soon, Alaska will run out of all savings accounts. It has been projected that if the State continues at its current rate, we will run out of our Capital Budget Reserve (CBR) in the year 2002-2003, then the State will begin to eat up the earnings reserve which will last until about 2007-2008, at which point, then the dividend will be impacted. Mr. Okeson advised that the dividend is calculated on realized income. Around 2007-2008, when the earnings reserve is gone, the only pot of money available would be the unrealized gains. As those unrealized gains are realized in the stock market, the dividend would be forced higher. A problem begins at about 2010-2011, when the State begins to run out of unrealized gains, and at that point, there will be no more savings. It is true that Alaska will still have its Permanent Fund corpus because that is constitutionally protected. There is no way to access the corpus because of the constitutional protection. People then will have a choice whether to fund government or continue dividends with massive cuts to government and/or new taxes. He proposed that a combination of the two would be essential. Mr. Okeson emphasized that a "do nothing" model will create tremendous problems for the State. Representative Bunde inquired if the dividend would "go away" even with cuts and with any newly imposed taxes. Mr. Okeson replied that it will inevitably go away. Even with cuts and taxes, Alaska will still need money from the Permanent Fund. He suggested that it could work if there was a combination of cuts and new revenues in the amount of $500-$600 million dollars. However, even then, there will be a $1 billion dollar deficit, which could require $400 million dollars of Permanent Fund money. Mr. Okeson proposed how the State responsibly could tap the Permanent Fund in order that it will not be "eaten up". Co-Chair Therriault questioned how can the State could preserve the value of the Permanent Fund for the next generation. Representative G. Davis questioned how secure the State was in earning expectations from the Permanent Fund. Mr. Okeson replied that the Permanent Fund has identified current dividends calculations based on the earnings. Earnings tend to be very volatile. We have not experienced that type volatility in the last 20 years because we have had some of the best "bull markets" ever in the history of the world. If the market was flat and did not grow at all, the earnings from those years would be zero. With five years of no earnings, the dividend would then decrease to zero. Mr. Okeson continued, an additional concern would be when there is no longer enough remaining in the earnings reserve, and then a down market occurs. There might not be enough money remaining in the accounts to actually pay a dividend. These are two fundamental concerns in using the current calculation. Some new plans use a technique which bases the calculation on a percentage of market value assets. Representative G. Davis agreed that this would be a better technique to use to protect the dividend. Mr. Okeson provided an overview of a graph display to the Committee members. The first graph illustrates the dividend line relationship to spending for education and essential services. The line below that shows general government expenditures. [Copy on File - File copy is not colored]. Mr. Okeson explained that a policy call made was to create a graph which allow dividends be the highest amount feasible so that the model could continue to work. In the House version, the dividends started at $1540 for a two-year distribution and then switched to a percent of market value. That approach would inflation proof the entire corpus principle of the Permanent Fund and take 5.88% of market value assets, splitting the payout at 50/50. One half would go to dividends and the remaining would go to government. If that occurred, the dividend would decrease to $1351 this year and would then slowly grow with the market until it climbed to $1800 dollars. Mr. Okeson acknowledged that in reality, the dividend would float up and down with the market. A couple aspects worked into the plan would help minimize the up and down motion of the market. The plan provides for a five year rolling average. Moving to market value assets will remove a lot of the previous volatility. Mr. Okeson advised that inflation proofed money would originate from earnings on the Permanent Fund. A policy call was made to inflation proof the corpus of the Permanent Fund. The proposed model attempts to undertake that action. Inflation proofing comes first in the proposed plan. Mr. Okeson pointed out that because of the plan's continued restraint on the growth of government, the savings could actually inflation proof all the accounts. The model guarantees that the corpus of the Permanent Fund is inflation proofed. Mr. Okeson spoke to the "intergenerational line" on the graph, which indicates that even though the corpus is inflation proofed, the State continues to completely inflation proof the entire fund. In twenty years, the amount in that account will be about $51 billion dollars. The purchasing power that we have today would be the same purchasing power available in 2020 as long as there continues to be $51 billion dollars. Representative Bunde inquired if a chart had been constructed which illustrates the State assuming no action and how that would affect the dividends. Mr. Okeson did not have that information available at this time, although, believed that the line would drop very quickly. Mr. Okeson pointed out that the original House plan contained a $5-$6 million dollar cushion. A policy call was made to the proposed plan and moved that money to provide for a higher dividend. Representative Bunde clarified that by having a dividend of $1540, the State could loose up to $9 billion dollars in the next 20 years. Mr. Okeson emphasized that there is no such thing as a "free lunch", and that with higher dividends, the State pays more money. Representative Williams questioned the amount of risk the proposed plan presents. Mr. Okeson replied that it does assume a little higher risk. There are Legislative tools which could help such as implementing a sales or income tax. He reiterated that there will be a significant cushion by using the percentage of market value and that the price of oil could be problematic. Representative Williams asked if it was possible to compare the House Majority Plan to the proposed plan. Mr. Okeson replied that the original House plan has had a "Mother of all Models" (MOMA) model run on it and that it would take a few days to provide that comparison. Co-Chair Therriault advised that this is a "modified" House plan with a dividend set at $1540 dollars. Mr. Okeson explained that the Permanent Fund Corporation created the MOMA model, an analysis which addresses whether a plan will hold up during market fluctuations. It is a complex model and takes into account how variables react with each other. The plan attempts to provide possibilities in a worse case scenario. The original House model held up very well under the MOMA run. Mr. Okeson spoke to graph #2, the Alaska Savings Accounts. Under this plan, the State begins with the Constitutional Budget Reserve, which is transferred in 2001 into the Alaska Income Account or the Earnings Reserve. Additionally, the graph shows the earnings reserve growing nicely. One of the things currently being envisioned is to provide more protection into savings accounts. There is a competing issue which goes back to the volatility issue. In bad markets, the State would begin to eat down into any savings. Mr. Okeson noted that the State does not need the high cushion. The Permanent Fund Corporation estimated that a 1/3 - 2/3 cushion would be substantial. One concept envisioned with the proposed legislation would be to take an amount that could be transferred into the corpus of the fund. Co-Chair Therriault advised that there is talk of creating a statutory mechanism which would automatically make deposits into the corpus. Mr. Okeson pointed out that the Legislature traditionally has done a good job of that. He pointed out that 2/3 of the amount in the account came from voluntary deposits made by the Legislature. Mr. Okeson provided a comparison between the Senate version of the bill and the House version. The Senate version begins with $1700 dollars for the dividend, decreasing to $1348. We are spending more on the dividend by lowering the intergenerational line and adding $50 million dollars new revenues in the year 2010. The House version does not contain those changes, which he noted was a policy call. Representative Bunde asked the most common type of new revenue that a legislature would propose. Mr. Okeson responded that the most common revenue resource would be taxes. Committee members agreed that version would be more risky. Representative Williams asked if there was a way to determine the amount of risk involved. Mr. Okeson replied that the MOMA model could provide that information. Representative G. Davis noted that in all the plans, revenues are fixed on the price of oil as well as the production amount. Mr. Okeson added that these assumptions are reasonable but not guaranteed. Co-Chair Therriault asked the level of cuts that have been figured into the first year calculations. Mr. Okeson explained that the cuts in both plans would call for a $30 million dollar deduction in FY2000. There would be a one time cut to debt service in the amount of $35 million dollars. There would also be a sustainable cut to $30 million dollars in FY2001. He pointed out that after that, there would be no more cuts, and that there would be no growth allowed except in education K-12. He continued, in FY2003, certain essential services such as public safety, transportation maintenance and the University would begin to grow at a rate of 1.45%. The rest of the budget would be held flat. Representative Bunde commented that holding it "flat" would be a cut to the cost of State government and asked what that percentage would be. Mr. Okeson replied that it would vary from year to year depending upon the inflation run. Whatever the inflation rate that year would leave a "real" cut incurred. That number would also be affected by population growth. Representative Bunde suggested that the State does have other options if necessary such as the implementation of user fees, etc. Representative Williams asked the risk factors indicated in the intergenerational line. Mr. Okeson responded that it is important to remember that with models not much volatility is assumed, but instead, a flat rate of return. Market volatility provides some risk and the higher the payout rate, the more it will vary. The Permanent Fund is a long- term asset. It needs to be thought of in terms of 50 years. The highs and the lows can be ridden out if we stay true to the payout rate. In the current system, the State must worry about market volatility because it is based on the market value of assets. He emphasized that it is essential to think of this as a long-term investment. (Tape Change HFC SS99 - 1, Side 2). In response to Representative Bunde, Mr. Okeson explained the potential loss difference between the proposed Senate and the House plan over a 15-20 year period. He projected that loss would be between $600 million and $1 billion dollars. Representative G. Davis asked if the State would be within a tolerable level of risk with the $1540 dollar dividend. Mr. Okeson replied that there are two types of risks and that the risk of not having a payment to government would be relatively low. The risk of accidentally dropping the level below that line would be reasonable. He projected that if the State goes above the medium case, it would be doing okay, and if the State chooses above the medium, it would guarantee that our grandchildren will continue to receive the dividend while eating into the purchasing power of our assets. Mr. Okeson reiterated that a higher dividend now will steal from future generations. If the State continues down its current path, the dividend has the potential of decreasing to zero. Representative Williams requested a comparison between the proposal and an endowment. Mr. Okeson explained that it is clear that the Permanent Fund was set up as some sort of endowment. The Permanent Fund was established as an endowment based on earnings as opposed to the percent of market value of assets. That is not done often and 70-80% of endowments in the world are based on percent of market value. He explained that there are good reasons for doing it that way. When that account was first established, the idea was that it would always be 100% bond money. Then those calculations make more sense. Realized income is very safe in a bond fund. A bond fund would not keep up with inflation because it would not be earning as high as an equity investment. Even though, it was called inflation proofing, what it really is, is a mechanism for extra savings. This all makes sense, although, when the investment assets were switched from strictly bonds to real estate and equities, the problems began. The mechanisms of management did not change at that time. He emphasized that current management tools need a "tune up". Representative Bunde pointed out that had the Permanent Fund continued to be invested only in bonds, the dividend would be approximately 1/3 of its current value. He added that the Legislature basically created a mutual fund for the people of Alaska. He inquired the twenty-year average of Permanent Fund dividends. Mr. Okeson replied that it was around $985 dollars. Representative Bunde pointed out that if any the proposed plans went into effect, the proposed dividends would average over $1000 dollars. Co-Chair Therriault asked about the drop from the first year's dividend to the $300 dollar dividend available the second year. Representative Bunde explained that the first dividend was determined upon the Zobel Case, and that it was not allowed to be distributed by longevity in this State. Representative Austerman substantiated that the first dividend program was "thrown out" and because, at that time, there was so much money coming into the State, the $1000 dollar program began. He requested Mr. Okeson to highlight what would happen with the money not distributed through the Permanent Fund. Mr. Okeson explained that the money used to fund these plans would be used to fund government services without having to impose a broad-base tax. The plan would put a priority on education, University, public safety and transportation maintenance. He stressed that big taxes and big cuts would not provide the base that the State requires. Representative Foster commented on inflation proofing. He suggested that the real purchasing powers of the original Permanent Fund have not caught up with current time. He pointed out that the State spends four times more on the operating budget than currently projected. He believed that indicated that everything is inflation proofed. Mr. Okeson responded that the first Permanent Fund dividend was an anomaly as a one time expected disbursement. He suggested that the following year, disbursement of $300 dollar was more realistic and more sustainable. Co-Chair Therriault pointed out that the original $1000 dollar dividend had been paid out of the general fund because at that time, the Permanent Fund was not large enough to support that dividend. Representative Foster emphasized that the spending power of the Permanent Fund is large. Mr. Okeson explained that the proposed plan would maintain inflation proofing. Representative Austerman pointed out that the majority of the e-mail and POM's he had received stated that the Permanent Fund Dividend not be touched. He asked if Mr. Okeson could guestimate when that plan would crash. Co- Chair Therriault suggested that would be the "do nothing" approach. Mr. Okeson noted he could provide a graph tomorrow which would show what a "do nothing" plan would "look like". Representative Bunde asked if an analogy to the current Permanent Fund to the national social security system would be appropriate. Mr. Okeson again referenced the graph of the "do nothing" chart included in member's packets. Co-Chair Therriault advised that the Senate Finance Committee had a bill before the Committee that was identical to the one proposed in the House Finance Committee. He did not know the changes that had transpired with the bill. Representative Austerman asked if the House would wait until a bill had been released from the Senate. Co-Chair Therriault noted that he did not know if a decision had been made regarding that concern. Co-Chair Mulder added that the intent was to begin preparation on a draft House bill to be incorporated into HB 1001. Co-Chair Mulder inquired the soonest date that the Division of Elections could put a ballot question out. GAIL FENUMIAI, ELECTION PROGRAM SPECIALIST, DIVISION OF ELECTIONS, OFFICE OF THE LT. GOVERNOR, responded that September 14th would have worked had the legislation passed by May 18th. The Division needs a minimum of 120 days from the date that the bill is passed and signed to conduct an in-person election. Much of that deals with the 60-day pre- clearance process required by the Department of Justice. Co-Chair Therriault asked if it was essential to get a clearance by the Department of Justice on an advisory note election. Ms. Fenumiai stated it was required because it would be a Special Election. Representative Bunde asked if it would be possible to have a "mail in" ballot election. Ms. Fenumiai replied that it would take less time to do a by-mail election which would involve no recruitment. A by-mail election could be undertaken in about 60-75 days. Representative G. Davis asked if a fiscal note comparison had been submitted for the by-mail election. Ms. Fenumiai replied that there was. The fiscal note for the in-person election would be $939 thousand dollars; a by-mail election fiscal note would be in the amount of $620 thousand dollars. Included in those costs is $100 thousand dollars to be used to produce an information pamphlet. Representative Williams stressed that this issue is the biggest concern happening in the State. He urged that a MOMA model be run as soon as possible. Representative G. Davis voiced concern with the risk involved with that possibility. Representative Williams commented that the Senate plan does not agree with the plan being considered by the House. Representative Austerman commented that he personally did not believe that the Senate intended to pass a plan back to the House. He noted that he had drafted a committee substitute which incorporates SB 231 and HB 1001. (Tape Change HFC SS99 - 2, Side 1). Co-Chair Therriault had requested Mr. Okeson to check the graph indicating sizeable cuts and how that would interact with the intergenerational line. Mr. Okeson spoke to the graph illustrating the concern mentioned by Co-Chair Therriault. The graph indicates a cut of $500 million dollars next year. He acknowledged that was a very large cut. The dividend would not change that much in the initial years but would extend out for longer. It would amount to $1700 dollars this year and then would rise up and shrink. He projected problems right away with use of the unrealized gains, thus, using up all the savings. The "eating up" of the savings accounts would not keep pace with inflation and that would be "stealing" purchasing power from our children. Co-Chair Mulder suggested that it is an aberration to assume that the dividend will not crash because the scenario contains a faulty assumption that the Board will sell off unrealized gains in order that Alaskans can access through the dividend the money they presume is theirs. He projected that there would be a sharp drop and that the Legislature would be faced with a gaping loosing budget. Mr. Okeson agreed. He suggested that the cuts might give the State six more years of inflated dividends. He noted the graph of the House plan underlined with the "do nothing" approach. He believed that it is the correct action to ask Alaskans to take a relatively small reduction to their Permanent Fund so that they could guarantee that they would continue funding into the future. HB 1001 was HELD in Committee for further consideration. ADJOURNMENT The meeting adjourned at 9:05 P.M. H.F.C. Special Session 10 5/22/99