MINUTES SENATE FINANCE COMMITTEE 28 February 1996 8:15 A.M. TAPES SFC-96, #31, Sides 1 & 2 SFC-96, #32, Sides 1 & 2 CALL TO ORDER Senator Rick Halford, Co-chair, convened the meeting at approximately 8:15 A.M. PRESENT Co-chairman Halford along with co-chairman Frank, Senators Phillips, Donley, Rieger and Zharoff were present when the session was convened. Also Attending: Senator Jim Duncan; Annalee McConnell, Director, Office of Management and Budget; Mike Greany, Director, Legislative Finance Division; and aides to committee members and other members of the legislature. Brian Rogers, Long Range Financial Planning Commission testified via teleconference. SUMMARY INFORMATION Co-chairman Halford introduced the agenda to consider proposals under an overview of potential budget strategies. Senator Jim Duncan was invited to join the committee and presented the Senate Democrats' Plan. It is critical that a long range financial plan be adopted this year that will close the fiscal gap over the long term. Debate and discussion must be had on a variety of approaches. The strategy as submitted by the Senate Democrats closes the fiscal gap in both the short and long term and commits the State and the Legislature to continue to have a balanced budget and keeps the fiscal gap closed as long as possible. The Senate Democrat plan is a multifaceted balanced approach using all fiscal tools available to close the fiscal gap. The three part plan submitted is: first, further budget reductions in State spending. The Long Range Financial Planning Commission recommended responsible budget reductions of $100 million over the next three years; $40 million in the first year and $30 million in the two succeeding years. It is a significant, responsible level of reduction. Second, stabilization of our revenue base. Senate Democrats recognize that this is another fiscal tool that needs to be considered. The Long Range Financial Planning Commission had proposed several revenue alternatives. We have not put any of those in our plan. Contrary to what has been said in certain news releases our plan doesn't tax more than anyone else. We built in the same new revenue figures from taxes that the majority built in. That doesn't identify any certain revenues. It is my understanding that the majority's position those revenues possibly would come about because of increase exploration and development in the oil industry. It was brought about because we passed the oil incentive bill last year, SB 207. Revenues need to be considered and we urged that debate go forward and that the various revenue measures that were recommended by the Long Range Financial Planning Commission be brought to a hearing and considered and if there are any of those that the Legislature finds acceptable and the public finds acceptable then we should move forward in that regard. The important thing to recognize in the Senate Democrats program is by closing the gap as quickly as we do and maintaining it closed for a period of seven years we give ourselves time in the State to responsibly address with great public involvement a new and enhanced revenue system. We are not forced to the point where we immediately have to adopt new revenue measures in order to keep the fiscal gap closed. For the next nine years we can have a budget in place, we can have a pattern in the State where we have more revenues available than expenditures without incurring a gap because of the way we close the fiscal gap and during that time we can responsibly address new revenue measures with the citizens of the State. So the first two parts of our plan are the State's spending reductions, the responsible level that we advocate, contrasted to a more in-depth reduction level which is advocated by another plan, which would over five years have reductions in today's dollars of about $600 million. A more responsible level of reduction at a doable level and consideration of stabilization of a revenue base is recommended. The third part and cornerstone of our plan is going to the people of the State and asking them to join with us in resolving the fiscal crisis over the long term and making a commitment to one of our highest constitutional responsibilities in this State, that of providing K-12 education to the children of this State. Like the Long Range Financial Planning Commission recognized, if you are really going to have a plan in place that closes the fiscal gap, the permanent fund has to be involved in some regard. A cornerstone of our plan is that a portion of the permanent fund earnings would be dedicated to the funding of education. If the people voted to do that it would close the fiscal gap for the long term. In contrast to the Long Range Financial Planning Commission's recommendations, our proposal does not cap dividends. Dividends grow quicker in the first six years under our plan than they do under present structure and continue to grow in years after that. We do not fund permanent fund earnings into the general fund for unspecified purposes. This would cause great concern with the public of this State if they thought we were putting permanent fund earnings into the general fund and the State Legislature was free to use those earnings for any need they might find including a growing and increasing bureaucracy. Our plan includes two pieces of legislation that would be necessary to enact it. One would be a constitutional amendment and that constitutional amendment would be placed before the voters in 1996. The purpose of that constitutional amendment is to dedicate a portion of the permanent fund earnings to an education endowment to fund K-12 education. The way that works would be that in the first year, FY 97, $350 million of the permanent fund earnings would be dedicated to education which would be about fifty percent of the full funding they would need and reduce the fiscal gap by $350 million. For the next six years the earnings going into the education endowment would increase by fifteen percent a year for six years until we got the full funding of education. That full funding is determined by projections made by the Department of Education. After that we would have an increase of three percent a year to meet increasing needs, increasing enrollments and other basic needs of educating our children. Full funding of education would be dedicated and assured. That money could not be used for any other purpose nor would it be necessary to appropriate part of it every year. That doesn't stop us from changing the way the foundation formula works if that's what concern people may have if they believe we don't now have an equitable formula. We are talking about the dollars that are necessary to fund education and there are not too many people in this State who believe we are going to need less money in the future. We probably are going to need more money in the future and how that money is allocated is a separate decision. That's the first part of our proposal. The second part is an appropriation bill that makes a renewed and continued commitment to the permanent fund. We appropriated $2 billion from the earnings reserve account to the permanent fund. This level of appropriation is being proposed in certain other pieces of legislation. We appropriate $1.2 billion from the earnings reserve account to the permanent fund and we additionally would appropriate $1 billion from the constitutional budget reserve fund for the permanent fund. The reason we do that is because the constitutional budget reserve fund balance of $2.3 billion is no longer needed. It is sitting in a savings account and would be available for access by three-quarters vote. We take $1 billion of that, put it inside the principal of the fund where it cannot be accessed. That, of course, then allows the principal to grow quicker. It also allows the dividend pool to increase and results in higher dividends for the first six years of the plan. The advantages of the proposal are pretty clear. One approach largely addresses the fiscal gap which is estimated to be between $400 million and $500 million in FY 97 by funding $350 million for the education endowment and the permanent fund. The remainder of the fiscal gap is covered with possible available revenue measures if we decide to pass any. If we don't we would need a much smaller appropriation than under the majority's plan of the constitutional budget reserve fund in order to balance the budget this year. We would take a very small portion out of the constitutional budget reserve fund. The second advantage is that we make a continuing commitment to funding education in this State beginning with $350 million in FY 97 and increasing to full funding by the year 2003. The third advantage is that we don't cap permanent fund dividends. The real advantage to the public is in addition to full funding of education we allow dividends to be larger through the year 2002 than they are under the present structure and a continued increase into the future. Another advantage is that we don't have to make large, draconian budget cuts this year or in the next four years to balance the budget. We have tough cuts to make because a reduction of $100 million over three years is not easy. Another advantage is that this approach relieves the pressure to immediately implement new taxes and allows more public involvement in that decision. Finally, it shows our commitment to the permanent fund by depositing into the principal of the earnings reserve additional dollars from the constitutional budget reserve fund. Everything is not as good as it sounds, and one question folks will have is what does the permanent fund look like under this plan as compared to present structure. If we don't ask the people, by their vote, to dedicate a portion of the earnings to the funding of education in this State, if we leave the permanent fund alone, if we allow dividends to grow uncontrollably, and we use the present structure there, what is the difference? The difference is that under our plan the principal of the fund would be about $4.9 billion less than it would be if we left the earnings untouched. It is important for us to put that decision before the people of this State. It does not erode the principal, we don't have less principal in the future. We have more principal. It just doesn't grow as quickly because we don't change the formula on inflation-proofing dividends. But, if the voters approved this and if the Legislature felt that maintaining the principal of the fund was the highest priority we surely could go in and change the allocation of the earnings from dividend to being a priority to inflation-proofing being a priority. There are a number of options. It also presumes we won't make additional deposits to the permanent fund. We know the record of this legislative body and past legislative bodies is to make those additional deposits when we have money available and we would have, under the democrats plan. We have made three deposits in the past and we undoubtedly will make additional deposits. The argument may well be that we need to continue to meet our obligation of inflation proofing. Clearly we have done more than meet that obligation. According to the permanent fund corporation, the actual dedicated principal of the permanent fund, if we had only the dedicated revenues flowing in, would be about $7.5 billion. We've fully inflation-proofed that and added an additional $1.2 in inflation proofing to the principal of the fund and added another over $4 billion of additional deposits. The public of this State can clearly see that we have fully inflation-proofed the fund. If anyone wanted to say what's the downside, that would be the downside. The principal does not grow as quickly under our proposal as it would under present structure. The people of this State want us to change the way we are doing business in this Legislature and the way the State is operating. They don't want to see us have a fiscal gap every year. They don't want to see us have to dip into our savings account of $400 million or $500 million each year to balance the budget. They want us to change things. And, Mr. Chairman, unfortunately, you can't change things without changing things. The most balanced approach is the best way to go. We change the way we are spending dollars because we reduce spending. We may change the revenue system if this Legislature agrees to it and the public agrees to enhance the revenue system. We changed the way the permanent fund earnings are being used but at the same time we protect the principal and we protect the dividends. Let me conclude, there are several charts and graphs that I passed out clearly showing the difference between the plans. The Legislature does have a responsibility this session. The last legislative session the majorities on both sides and the administration and most of the minorities said we need to develop a long range financial plan. We put together a citizen commission of fifteen to do that. They had charge of coming back to the Legislature with a long range financial plan that we could consider. If we didn't agree with it at least we could adopt the long range financial plan to close the fiscal gap. The public should ask us whether or not we have put together a plan that closes the fiscal gap. Has the Legislature adopted a plan that uses more than one of the tools available to close the fiscal gap? Have they used a balanced approach? I would suggest the long range financial planning commission's approach was balanced. The Senate Democrats plan is balanced because we talk about budget reductions, new revenue measures and recognizing that there needs to be something else to fill the rest of that gap in the permanent fund earnings, by a vote of the people, as one of the fiscal tools that should be considered. If you talk only about budget reductions in your plan that's not using all the fiscal tools and that's a mark of failure, not success. The second question they should ask is do the proposals that are before the Legislature close the gap for the long term? If you put budget reductions on a piece of paper and say our plan is to reduce spending for five years those spending reductions are unrealistic if they do not close the gap for the long term and if after those five years the fiscal gap immediately begins to grow. Under the Senate Democrats' plan we close the gap in two years, develope a surplus for the next seven years, which flows into the constitutional budget reserve fund so it can't be easily spent, and for the next nine to ten years we have closed the fiscal gap. Under the Senate Majority's plan the fiscal gap is closed in five years, as contrasted to two under our plan, and then it immediately begins to grow again. It hasn't been closed over the long term and when the public asks that question of these three plans they will see that two of them succeed and one of them fails. The third question is do the plans permit the Legislature to close the fiscal gap over the long term, or is it just a plan on paper only? (Temporary loss of minutes due to power down of all recording and teleconference equipment.) Clearly the commission's plan closes the gap over the long term, because there are commitments there the Legislature can't go back on. The Democrats plan closes the gap over the long term because there are also some commitments there that we can't go back on. There is a more responsible level of reduction and we have a constitutional amendment that permits us to close the fiscal gap. The majority's plan doesn't commit us to anything over the long term. It is a one year plan only. And we cannot commit future Legislatures. So, if you ask those three questions, and you get the answers, I think you will clearly see that two of the plans succeed, one of the plans fails, and the public will not be pleased if we walk out of this session without a plan in place where we can answer yes to all three of those questions. Co-chairman Halford inquired if he and the six co-sponsors supported the $40 million of reduction proposed by the commission for this year. Senator Duncan advised that the Senate Democrats do support the level of reduction of $100 million over three years but not the specifics as recommended by the Long Range Financial Planning Commission and Governor Knowles. Co-chairman Halford indicated that he appreciated the fact that the analysis of their own plan lays out its biggest questions and that their projections really do give us a long term look of what it is proposing. In today's dollars the long range analysis of what happens to the permanent fund, basically says that for other than the time it takes to use up the deposit that's made in the first two years, the principal of the permanent fund, ten years away, fifteen years away, will be actually smaller than it is today and will from then on be declining. We will have made a decision in terms of what the permanent fund is for, in this, the generation that also spent the remaining three- quarters of the wealth of Prudhoe Bay. Senator Duncan said he was glad that the Co-chairman pointed this out. He suggested that if you look at the Majority's plans and today's dollars you find that it does not continue to grow in nominal dollars as would be expected. There clearly is a difference in the principal of the permanent fund. It is the public who makes the decision that the permanent fund has to play a role in this State other than just paying dividends and inflation-proofing itself. It has to help close the fiscal gap. That fund is sitting there and then we cannot fund education, public safety, resource management, and transportation projects in this State. That is a decision the public will make. Many times these projections by the permanent funds are very conservative and our real rate of return may be much better that what they are projecting in their runs. That's how we build up that reserve account. Every time additional dollars are available you are going to want to put it in the permanent fund. So the principal will grow. And let me suggest, under your plan, the problem is by the year 2008 you will have spent every dime on the table including the constitutional budget reserve and the earnings reserve account. Co-chairman Halford stated that was not the case according to the projections. What is the plan versus the status quo? The value of the plan once you get passed the initial deposit, in your own projections, the permanent fund real value declines from thereon indefinitely. So, in the very long range projection the permanent fund's value eventually goes to zero. Senator Duncan said that he did not assume that at all for these reasons: one, it is the people who make this decision; second, we always have the ability to change the formula that says what shall go to dividends and what shall go to inflation-proofing. If some time in the future people want to change that formula they can. We always have the ability to make additional deposits in the permanent fund and I am sure that will happen. But there is another consideration. If you hold the permanent fund, the public says that they don't want to use that, then we have to make some tough decisions of what we are going to do for basic programs and services in this State. Are we going to fund education adequately? Probably not, if we don't develope some source of revenue to close the fiscal gap. Are we going to fund public safety, resource management and transportation projects? Probably not. Are we going to meet our infrastructure needs in this State? Probably not. I would suggest to you that we are actually ending up giving people two types of dividends. One, a permanent fund dividend and one an education dividend, and in the long term that benefits people on the local level. They have kids to educate and it costs money and if the State doesn't pay for it local communities may have to. And your property taxes may go up. Of, if the State doesn't fund other services, local communities may have to. All we are suggesting is the public should have before them the opportunity to decide what they want to do to close the fiscal gap in the future and if they want to try to avoid the tremendous negative impact on the economy that would come with a high level budget reduction, because the only way the majority's plan would work is with continued budget reductions. They will hurt the economy. Economists across the State will tell you that for every $100 million in budget reductions you are going to lose 1,200 to 1,300 public and private sector jobs. That is a tremendous impact. Co-chairman Halford said that one of the interesting twists of the Senate Democrats' plan is that unless the voters agree to this long range change in the future of the permanent fund and the reduction in its eventual principal the deposit to the principal of the permanent fund that is very strongly supported in every poll that anyone takes does not take effect. Basically, unless they go along, the $1.2 billion in reserves does not go into the principal. Is that an intentional effort to draw them into confusion as to how to really protect the permanent fund? Senator Duncan advises that it is not. If this proposal were brought to the floor and put before the people and the $1.2 billion in earnings was deposited before the vote, I don't think you'd have a problem with that. The real tie to the effective date was taking the money out of the constitutional budget reserve. We made an additional commitment of $1 billion in constitutional budget reserve fund because if this was approved by the voters we wouldn't need that. But if it is not approved you would probably want to keep that in the savings account. So the real tie was on that $1 billion. We put the appropriations together. The Democrats would agree that if this proposal were put before the voters of the State that the $1.2 billion in earnings reserve could be deposited immediately. It is the $1 billion from the CBR that should be tied to the effective date because that depletes our other savings account which we may need if the voters didn't approve this. If the voters did not approve this it is a clear signal to this Legislature they either want new taxes, income tax, some other type of taxes, or large budget reductions. Senator Rieger commented on the point of deposit. In Senator Phillips district fifty-eight percent opposed the deposit to forty-two percent favouring it. Co-chairman Halford indicated that it combined the deposit of the permanent fund reserve and the budget reserve to the principal of the permanent fund. It was not a single question. Senator Phillips concurred that it was combined. The question was asked on two separate accounts where one was to spend the constitutional budget reserve or put it in an account and they said "yes" and then they had four choices of what to do with the earnings reserve account and they chose fifty-two percent out of the four choices to make the deposit into the principal of the fund. That was last year. This year I just combined the two. Senator Frank asked if the additional funds that the State will be spending in the next fiscal year and add them to the other funds the Governor has proposed in his spending plan, that totals $89 million and subtract $70 million, if we were successful in making that $70 million reduction, you would still have a positive or an increase in the amount of money that the state would be spending this year. Which economist were you relying on to suggest the majority's plan would send the State into a tailspin? Senator Duncan clarified that he did not specifically say an economist had analyzed the majority plan. What the economists have told me is that budget reductions of the following amounts would have an impact on the economy. He referred to information which had been provided by David Reaume, a Juneau-based economist. Senator Frank asked if this was the same economist who said we have a $3 billion surplus and no problem. Senator Duncan advised that Senator Frank might contact other economists what the impact of budget reductions are. It does not make any difference which economist is used. The estimates that are used by economists at large are that when you have reduction in government spending you are going to have an impact on the economy. You are going to have job loss not only in the public sector but also in the private sector. That formula was used in 1986 when we had budget reductions and it really hasn't changed. At that time Scott Goldsmith from ISER and others were saying the same thing. We've talked generally and the projections are for every $100 million in cuts that we are going to see 800- 900 state jobs lost, 100-200 private jobs lost, and an additional 360-400 across all sectors. 1200 to 1500 jobs per $100 million. If you are going to cut $70 million this year which is really $140 million in today's dollars, you are going to have impact. If you are going to cut almost $600 million in today's dollars over five years you are going to have impact. Some will say they are not all sure that happened in 1986 but let me tell you what happened to total government spending in 1986. We don't like to think that government is important to the economy of the state but it is. Senator Frank interrupted to say that he would just like him to provide an economist to back up his statement. Senator Duncan said that he was just putting facts out. The majority budget proposal cuts spending by $600 million over five years. Co-chairman Halford asked how a cut this year could be applied to what its inflation effect will be five years away and then bring that back to today's impact on the economy. This is compounding things ahead of time. Senator Duncan referred to this year. Discussion between Senator Duncan and Senator Frank over which chart was being used. Senator Duncan advised that the chart being used was prepared by the majority plan. It was a chart produced at his request on the majority plan projection by OMB. This was prepared in today's dollars. One of OMB's staff people who had the model for the Long Range Financial Planning Commission did the chart and it clearly shows in FY 97 that the spending cut in today's dollars by the majority plan is $140 million. Co-chairman Halford suggested that there is no way you can add one year's inflation onto a $70 million reduction and make it into $140 million. Senator Duncan said he would let OMB defend that figure. Senator Rieger pointed out that at a level of spending that is around $2.4 billion a year, if you have three percent inflation and you don't adjust for inflation that is a $72 million real cut. Over five years it is about $400 million if you do not adjust for inflation. Over one year it is about $70 million. Senator Duncan concurred in what Senator Rieger stated. He felt it was a fair assumption that what the Senate Democrat plan suggested, and what the Long Range Financial Planning Commission suggested was not to let the government grow uncontrollably. There was a Long Range Financial Planning Commission that was appointed, five members by the republican leader of the Senate, five members by the republican leader of the House and five members by the democrats and they carefully evaluated where the State should be going and what level of spending reductions this State could live with. Their recommendation and our recommendation was that government spending should grow by population increase and one-half of inflation in future years. Not full inflation, one half of inflation. It is unreasonable to expect that you can continue to reduce government spending forever and not allow inflation and population growth to have an impact. Brian Rogers, chairman Long Range Financial Planning Commission testified by teleconference. He discussed why the commission reached some of its recommendations and reviewed some of the goals that this or any other plan should seek to achieve. There are a number of problems with Alaska's finances. Any long range financial plan must address a series of problems. The first one is that annual unrestricted general fund spending exceeds recurring unrestricted general funds revenue. That is the first of several financial problems that have to be addressed in the long run. The second set is that Alaska is overly dependent upon one revenue source for its unrestricted general fund revenues and that is Prudhoe Bay oil. It is a very volatile one due to the volatile nature of oil prices in the world. It is also a declining revenue source that is not sustainable over the long run. A third problem is that while there is a direct connection between population growth and the need for spending on certain State services, unlike the other forty-nine states, there is not a direct connection between population growth and the revenue needed to support that spending. What that means is taking the fact that we are out of balance, that we are dependent on one source that's declining, and that there is no relationship in population growth, seeing the current spending levels are not sustainable with the current revenue level. What the commission found was that State spending exceeds the national average by a significant margin. They also found that state revenues from individuals and businesses excluding oil revenues fall far behind the national average if you look at revenues on a per capita basis, which may not always be appropriate. They found that much of State spending is really beyond the direct control of the finance committee. It is driven by statutory or constitutional requirements that would need to be changed to achieve significant cuts. (tape SFC-96 #31 switched to side 2) Finally, state spending on operations, on capital projects and on the permanent fund dividends is a major part of the economy and changes in the state spending pattern or for that matter changes in the level of taxation affect the economy but not necessarily in the exactly same way due to Federal tax shifting in a proportion of benefits received or taxes paid by non-residents. The effect of different cuts for different taxes change. The ideal financial plan would ultimately balance recurring revenues with recurring expenditures. It would reduce the State's dependence on volatile revenue sources, such as oil, and conversely increase the proportion of the State's revenues that come from a stable or predictable source. It would provide a greater link between population change and state revenues. Because oil will still be a key part of the state's revenue mix we would need a cushion against an unexpected downward spike in oil revenues. We need a plan that had a level of spending acceptable to the public in aggregate while still providing a level of services the public wants from the State. And to also have a level of taxation that was acceptable to the State. Or maybe putting those two together, better stating it, that balances the level of spending and taxation in a manner acceptable to the public. We thought the ideal financial plan would be sustainable over the long term and that would require leaving some of the oil wells for future generations. None of the six plans really do follow these goals, in dealing with sustainability, reducing the revenue volatility, balancing the level of services and spending against taxation and revenue, leaving some oil wells and being politically acceptable. Look at Roger Cremo's plan, long range financial plan, Steve Rieger's minority report on the long range financial plan, Dave Rose's plan, and then the majority and minority plans. In the long fun, Cremo is probably the most sustainable, but it requires extreme sacrifice in the short term. In terms of sustainability, the long range financial plan comes next and then Rieger and Rose and then the minority and majority plans. The revenue volatility probably has the same spectrum. In terms of the level of services you get a different mix. If you were to take each of the goals of the plan and set forward a matrix you would find that the different plans meet different objectives. You or any other observer could rank the plans, but on the spectrums I would urge that you to do so or find a neutral party that could do so. The long range financial plan attempted to find a balance among these goals. In cutting spending we chose to cut $100 million over three years. When we add the $75 million a year in inflation on the existing $2.5 billion budget over three years that came to a fifteen percent reduction in State services. That contrasts with about a twenty-five percent reduction in State services in the majority plan and probably a thirty percent reduction of State services in the short term for the Cremo plan. Our plan increases state revenues by about $150 million in the short term and then uses the income tax as the next revenue source. We considered sales tax and property tax as the other two broad taxes that do link taxation and population growth and the feeling was that both of those taxes should be left to the local governments of Alaska, although there was a lot of sympathy for statewide sales taxes being easier to administer and easier for people to swallow politically than an income tax. There were people who felt that an income tax was fair. Our plan establishes the permanent fund as an endowment and builds that endowment through an averaging approach that builds inflation-proofing in, retains a portion of the earnings, increases the mandatory deposit into the permanent fund and then has several special appropriations into the permanent fund. We also suggest and a fundamental piece of our plan is that there be a review in three years. We suggested that take place in the interim between the 1998-1999 sessions. That coincides with a new gubernatorial election and a commission should report following that election with a sort of mid-course correction, a look at where we've been and how successful the legislature and governor have been in closing the fiscal gap and reducing dependence on volatile revenues and the other goals. At that point the decision can be made whether further cuts, further revenues, further reduction to the permanent fund dividend, or some other approach is most acceptable. That is the problem of Alaska's fiscal gap and its dependence on volatile sources. It is a difficult one and has been grappled with by a number of legislatures. I would urge you and the other members of the legislature and the governor to try and avoid to the extent possible in an election year, partisanship on this issue. This is a problem that will be best solved by statesmanship and a bi- partisan solution is much more likely to stand the test of time. Senator Zharoff asked if in the recommended reduction of over $100 million over three years an evaluation was done of what that would cost in terms of jobs, state, private or other? Brian Rogers advised that they did not do a specific evaluation of the plan. In trying to devise a plan, they based part of their decision on the work that was done by ISER and others that analyzed the differential impacts of cutting the dividend versus cutting State spending versus increasing revenues. The depth of work on that issue has been done by ISER in the late 1980's and the most recent report in 1991. Clearly reductions of that nature will cost jobs and have a negative economic impact, cutting the dividend affects to an even greater extent and so does the imposition of taxes. Look at that ISER report to realize the differential impacts of the three courses of action. Co-chairman Halford asked if in looking at the in state economic impact does it need to be isolated it in that way? It has been easy to export the tax burden to basically the world oil market but once you start choosing between taxing within the State of Alaska to pay salaries within the State of Alaska there is not any real wind there or is there? Brian Rogers responded that if the purpose of the taxation is solely to pay taxes, no there is not a wind there or a loss there except to the extent there are some tax substitutions by reduction of Federal taxes or some collection from non-residents. It is important to recognize that while we all have heard the number seventy percent of public spending is for salaries the salaries and benefits for State employees are about a quarter of the Alaska general fund budget with a major proportion of the general fund budget going for education, municipal systems transfer payments, things that don't go directly to salaries of State employees. Co-chairman Halford asked if the education component in the majority of that also go through to salaries for employees funded through State and local contributions? Brian Rogers indicated yes. Senator Halford said the numbers still go back up again when the actual spending of the pass throughs are counted. Brian Rogers again indicated yes. Co-chairman Halford said the hardest thing to assess, and he assumed that it is different when you are sitting the center of State government, the impact of tax that transfers jobs from the private sector to the public sector may have a very significant positive impact on one area of the state and it may have a very significant negative impact on another area of the state. If there is no net gain then I would hope that we do not look at those places such as the permanent fund revenue stream for example. Brian Rogers responded that one way of looking at the problem might be that Alaska has about a $14 billion economy and we have $0.5 billion hole in that economy. One approach might be to look at what method of change in spending and revenue maximize the proportion of that $500 million hole that is filled outside the State of Alaska versus inside the State of Alaska. That message would say go for oil taxes first, and go for an income tax second, and sales tax third. Those kinds of actions would have other deleterious impacts on our economy. Co-chairman Halford said that one of the things Mr. Rogers started with was a statement that has been significantly disagreed with by the Juneau economist Mr. Reaume, and that is we are spending more than we are taking in. Mr. Rogers said that he had not read all of Mr. Reaume's information and he felt maybe he didn't understand just what he was getting at. The portions that he did understand he felt that he was correct in saying that portions of revenue coming in are devoted to specific purposes and not included in a balancing and an example of that is the twenty-five percent of Prudhoe Bay's revenue and fifty percent of other oil field revenues that are deposited into the permanent fund and the tax settlements that are coming in we have not, in our work, nor has the Legislature counted that in the annual available for appropriations because of prior decisions by the voters to segregate those funds. The voters decided in 1976 that the twenty-five percent would go into the permanent fund and not be available and the voters in 1992 and 1994 dealt with the constitutional budget reserve. He is correct in saying that is revenue but he is incorrect in considering it to be unrestricted revenue. Co-chairman Halford said that Mr. Rogers' threshold statement was that the State is spending more than it is taking in on an annual basis. Is that correct in the dictionary terms or is that only correct when looking at the general fund component? Mr. Rogers said that he believed his statement was unrestricted general fund spending and specifically chose those words because the work in closing the fiscal gap that the commission focused on, unrestricted general fund spending. Certainly, the voters could decide to stop putting money into the permanent fund and make up a $250 million a year of the deficit through that action. That's a choice that could be made that I believe no one on the commission could have supported. Co-chairman Halford said that was most likely where the economist in question and the whole process kind of go head to head. It is not understood that there's a significant limitation on the terms. Essentially both of the statements are correct. Senator Zharoff asked the basic intent of having the permanent fund in place. Mr. Rogers advised that he was on the staff of the State House when the constitutional amendment HJR 39 was debated and recalled at the time the amendment was being debated was on setting aside a portion of Alaska's oil wells so we could deal with the State's need once the oil was gone. Most of the discussion in 1976 focused around whether it was ethical for the current generation to spend the windfall that had been millions of years in the making. The decision was it was not ethical and that it was important that a portion of that oil well be saved to benefit future generations. In the debate and the discussion over the summer of 1976 it was primarily on insuring that there would be revenue sources available to the State once the oil was gone. In the next year, after the permanent fund was adopted, the discussion at that time shifted to whether this was a trust fund or a development finance fund and there were two approaches at the time. One, use the fund to build up Alaska and two, it was more the nature of a trust fund. After the 1979 oil price increase the idea of protecting the funds from raze by the Legislature by using a dividend came up. It was in your first term, Senator, and that of Senator Halford that the issue of how to preserve the fund as a trust and how to avoid allowing it to lead the way as was the case in Alberta, through development projects, that the dividend was proposed and came forward. The long range financial planning commission in our report, attempted to balance both the initial trust fund to use for State government and protect that trust fund by giving out a dividend in the plan that calls for some reduction in the dividend but preserving the dividend. Senator Phillips added that in 1969 when there was the bonus lease of $900 million essentially most of that money was spent on government which triggered the discussion about having a permanent fund for future generations. That is why in the late 70's early 80's we had a symbolic $900 million deposit sponsored by Representative Freeman as a replacement for the first $900 million. Mr. Rogers concurred. Co- chairman Halford stated that it was a creation of a coalition that never really reached a conclusion as to the absolute purpose of the money but recognized some of the responsibility to carry some of it forward. Many people thought it was for government. Some thought it was to avoid spending it. Every new revenue projection increased the availability for appropriation by hundreds of millions of dollars in the 1979-1980 era. Mr. Rogers concurred. The votes cast in the Legislature on the deposit in those two Legislatures were probably among the best votes because they did prevent the budget from growing even further and creating bigger fiscal problems today. Co-chairman Halford said that whenever asked about what should be done with the money he answers that "our kids should get to decide". Senator Zharoff said that at some point down the road during this period of time the discussion were that fifteen to twenty years down the road, which we are at that point right now, and the revenues of the State would start to decline then the earnings and not the principal of the fund could be utilized to some degree to supplement the government spending or start to bring it down in a reasonable fashion. We are at that point now and we might be deviating from that and maybe there is a little misunderstanding of all the stories that are going out that we are getting into the permanent fund, when actually we are not. The basic intent, initially, what was on the ballot that was sold to the people was not to say that we were going to put this money in there and continue to keep putting it in there perpetually and not be able to get to the earnings at some point. Of all of the plans in front of us it appears that no one plan is the absolute solution. It is going to take a combination of some of these plans put together or maybe one plan in its entirety along with others. This is best achieved by taking a bi-partisan approach to resolving this fiscal gap. Senator Phillips asked for a history on the purpose of the dividend. Mr. Rogers stated the major driving force for the dividend was the protection of permanent fund principal. The linking of the annual dividend to investment performance of the fund was the greatest security that the fund principal would not be raided either directly or indirectly through subsidized loans in a fashion that they eroded the principal. The second effect was that the State was rolling in so much money that there were not enough worthwhile things to spend it on and that a number of legislators were looking at ways of getting a portion of revenue off the table to avoid having significant budget growth. A third reason was that a study that had been commissioned about a year before the dividend finally passed by the Legislative Affairs Agency, Legislative Research Division, the effect of State spending was very disproportional among the legislative districts of Alaska and that some districts had very high state spending, some nearly none and we were looking for a way to boost the impact of State money spreading around to communities in the fairest way possible. The dividend was one way of doing that. There were per capita appropriations as well. The strongest reason was to protect the permanent fund principal. The other two were to take money off the table and try to spread it around more equitable. Senator Phillips recalled the first half and the dividend was sold to the public because the public felt they could spend the money better than the Legislature. The second half of that was the dividend was supposed to be used to purchase the services that you wanted. That was an argument by the main proponents, that the public can spend the money better than the Legislature and that the money was to be used to purchase the services to be used or that were wanted. Co-chairman Halford concurred. Governor Hammond, as the advocate, used the dividend payment in arguing against State expenditures, saying, in some cases, different people would make different choices in how they would spend the money. Senator Phillips said that the dilemma that we were in now was that the perception of the second half of the argument has been diluted over the past fifteen years because now a lot of folks feel it is a trip to Hawaii or whatever. The Anchorage area is going to be going through a vote here in April and they are going to be voting on some bonds. If they choose to go ahead and vote in favour of the bonds that means increased taxes would take part of your permanent fund dividend and pay the increased taxes for the services that you requested or wanted. Co-chairman Halford stated that was an individual choice based on individuals and it is fairly allocated across the state, probably more so than anything else we do, and it has the maximum positive impact on the overall economy of all the expenditures we make. Senator Phillips cautioned that he did not want us to lose the foresight we had fifteen years ago stating that you pick the services your request because you as an individual citizen have a better ability to spend that money than the Legislature collectively. Co-chairman Halford said that former Governor Hammond carried that one step further saying to leave it there as a payout and if you need it tax it back for services that people want to pay for collectively. There is a strong disagreement on whether that would ever occur in that format or whether people would go back to the dividend directly. Senator Donley said that he corresponded with the commission on the formation of the plan and this is to address point number one about what the purpose of the dividend originally was to protect the corpus, give the people a stake in the corpus and of the permanent fund and promote its increase over time because it would be politically protected by the dividend program. The commission in recommending capping the permanent fund dividend did not look instead if you had to propose to do that to a percentage reduction in the dividend. Currently it is fifty percent of the interest on the permanent fund. It doesn't make any sense to simply cap it if it is going to be used as a revenue stream and you can achieve the same amount of revenue by reducing the percentage of the interest that goes to the dividend annually and you would still preserve the link between the total corpus and the amount people get in their dividend and preserve that number one principal of protecting the corpus. Mr. Rogers said he would agree that's one of the biggest problems with the capping of the dividend in the plan advanced by the commission. Senator Rieger and himself were some of the strongest advocates on the commission for not breaking the link between investment performance and the dividend payout. We were in the minority on the commission on the issue of capping the dividend. Co-chairman Halford asked on the topic of the commission, if $100 million were taken out of the dividend revenue stream and used it to fill the spending gap would that have a net positive impact on the internal economy of the State of Alaska as a unit or a net negative impact. Mr. Rogers felt it would be a negative impact. Senator Steve Rieger was invited to testify before the committee. The minority report was built on the work that the long range financial planning commission did. The commission did look through a number of issues and tried to get a reasonable base line about what the future revenue sources would be from a variety of alternatives of taxes or user fees and what the unrestricted revenues would be. They also looked at the projected population growth of the State, used inflation assumptions and what they did was create a large number of building blocks which had some degree of objectivity to them. What happened in writing the minority report was using the assumptions which were developed by the long range financial planning commission even though they might not have been exactly what would have been crafted in a vacuum as far as the choices made. The commission did pursue two courses: one was a variation of an endowment approach, and the other was a variation of what was sometimes referred to as a SB 51 approach. The spread sheets contained in the reference packet, labeled the Rieger Composite Scenario are really the result of the commissions review of the Senate Bill 51 type of scenario with some modifications they made. The basic premises which are important for closing the fiscal gap are three big tools that are available: budget cuts, interest earnings and taxes. The conclusion is that any two of those could close the fiscal gap. The two that should be used are budget cuts and interest earnings. Obviously no single one of those three tools will get you there. No one disagrees that budget cuts are necessary. The budget cuts incorporated in the Composite Scenario are substantial and they are an absolute necessary part in getting the State onto a sound footing. The use of interest earnings in this plan are off of the permanent fund. The principals that are applied here are that not a penny has been earned on endowment, not in the permanent fund, the university foundation or any other until you have at least exceeded inflation. Inflation- proofing as it is commonly used should not only be the first priority in the treatment of any endowment, it should not be on the table as a consideration of whether it should be a priority or not. It should not even be considered earnings. It should be an automatic thing that you don't even count your earnings until you have first exceeded inflation. The present statutes say the five-year average in pay out for the permanent fund is a reasonable approach for permanent fund payouts. We should continue the policy we have had of paying out half of the actual earnings of the fund as a dividend. It is not necessary to go beyond that policy in the foreseeable future. What has been done during the last ten years is not only paying out half of the earnings of the fund in a dividend, we are also paying out half of the inflation-proofing. If there is fourteen percent earnings and four percent inflation we don't say we had a good year by earning ten percent above inflation and we'll pay five percent out in dividends, we pay the five percent out plus the two percent of the original four of inflation. That tends to put a squeeze on the permanent fund to do anything except cover dividends and cover inflation-proofing. The permanent fund, because of that, is perpetually at risk of being eroded by inflation. We even saw a plan today which said that is a consideration that should be there, whether to continue inflation-proofing. Inflation-proofing should be first and what should be on the table for our consideration is the real earnings of the permanent fund. What SB 51 does and what this composite scenario does is say yes, inflation-proofing is off the table. The payment of dividends is based on the performance of the fund after that. The rest is available to help close the fiscal gap. It is step number two after the first priority which is budget cuts. Some of the smaller measures that the long range financial planning commission developed, tobacco tax, alcohol tax, highway motor fuel tax, user fees and so on, it was not only a significant set of revenue without going to any major new tax, it was more than necessary. What the spread sheet shows instead of a zero and five it is a zero and three. Even if you did not take some of the measures which are proposed there it is a zero and three. Since that time a couple of things have changed. The permanent fund since the commission did its deliberations last summer has had a banner year. The principal is significantly higher than what it was in the assumptions that were used here. That is a plus. The long range unrestricted fund forecast that has come out in the fall is lower, that is a negative. There is a curve that drops off more steeply and because it based primarily on known economic activity, reserves, revenues, and it does show the need for continued economic development. That has to be a given that is in all these plans. There has to be economic development to offset some of the other fields that pay out. The other thing that has changed is that the permanent fund has adopted a very conservative, long-term total earnings assumption of 7.17 percent. After the next couple of years that is there long term assumption of what they are going to earn totally. That seems somewhat low but it does tend to change if you were to adjust this somewhat, the amount of earnings that are available for whatever, whether it is dividends or for the use of the remainder after dividends. What these numbers show is that you don't need a state-wide sales tax or a personal income tax, but you do have to use interest earnings and you do have to use budget cuts to close the gap and the numbers here are representative of what that plan would look like. Just like on inflation-proofing of the permanent fund, the discussion on the budget has tended to ignore inflation. The permanent fund uses as inflation assumption for the next five years 2.99 percent next year and then 3.18 percent for the next four years. Just compound that out and apply that to the budget we have today. If there is no adjustment for inflation and just hold nominal dollars of the budget constant for the next ten years, that is a cut in real dollars of $409 million. What has been observed from the plans that are generally proposed is that there is discussion of the nominal cuts, should it be zero, which perhaps Dave Reaume was talking about in his column, or $100 million as the long range planning commission used or $250 million, those are dwarfed by the fact that if you hold the line against inflation you've cut $400 million, then it is a question do you cut another $100 million on top of that or $250 million all these plans do talk about using interest earnings and budget cuts to get you there. The Governor is saying that we should do a state-wide income tax before we take a look at anything that has to do with the earnings. Senator Rieger disagreed with that but said excluding that exception all the plans work off the assumption of using interest earnings and budget cuts. The majority report will now use interest earnings off the constitutional budget reserve, AHFC, AIDA and it is the same concept. That is the answer of how we get out of here. What this plan does is put the permanent fund on a more sound basis because the inflation-proofing is automatic. It puts the dividend payout on a more rational basis because we are paying out based on the actual performance of the fund. It does continue, as Brian Rogers pointed out, the link between the performance of the fund and the size of the dividend is vastly preferable to capping the dividend at a dollar figure. That would be an open invitation to pressure for inferior investments by the fund because no one could say that this would hurt the payout. This is critical to maintain. The Rieger Plan basically incorporates SB 51 and budget cuts and is open to other conditions. Senator Zharoff said that he saw a report indicating that as the principal of the permanent fund continues to grow the more it will take to inflation-proof it and at some point the inflation-proofing starts to almost take up its entirety so it does have a definite affect on whatever there is as far as undistributed monies as well as on the distribution of the dividends. Senator Rieger noted that the projections tend to match what today's situation is. Right now inflation is less than half of the returns of the fund so that isn't the case. But in the past inflation was more than half of the total return and that was the case. (change to tape SFC-96, #32, Side 1) If inflation-proofing is made automatic and the policy of five year averaging is continued, which is a good policy and the commission also considered a fixed percentage payout based on the size of the principal instead of actual earnings, you would have to have poor earnings for a number of years before you could not make a pay out. There could be a fluke situation, but on a five year that is not very realistic to expect with good management. Co-chairman Halford asked about the averaging being washed out in five years from now what would be the percentage reduction in dividends from what it otherwise would be. Senator Rieger said that if you make the same assumptions you still have a variable and that is how many people are going to come into the state for the sake of getting the dividend, if it grows much beyond on where it is today. It might be there is no difference because you just have a fewer people dividing a smaller pie instead of fifty percent more people coming in because we are trying to pay some phenomenal quantity in the dividend. If you make the assumption we have walls on our borders the estimate is that it would be something like a twenty-five or thirty percent change. Co-chairman Halford referred to Rieger plan, page two, annual dollar cut in per capita dividend from status quo. The cut starts out very small because it is averaged but when we get out to five years from now it is forty percent. It seems to run between forty and forty-seven percent reduction from then on. Is that figure accurate? Senator Rieger said he wasn't sure if the figure was accurate. It depends on the performance of the funds and the relative size of inflation and the total return. If inflation were nine percent and the total return of the fund were ten it would be a very significant cut in what we were paying out. If the inflation were one percent and the total return were ten there would be a very insignificant difference between the two. The permanent fund is using extremely conservative total return assumptions compared to what they have done. Senator Halford said that it seemed to be a major reduction if the projections are anywhere near what the numbers come out to. Senator Rieger said that the hidden assumption is that the payout can grow forever without attracting people, which has not been the demographic experience we have had in the case of the longevity bonus. Co-chairman Halford said that any of the other projections we see shows the payout growing. The minority's package showed dividends basically in real dollars staying at about where they are now indefinitely. Basically the dividend in today's dollars by the year 2010 is $961. In purchasing power there is no difference. The dividend is probably not going to change significantly although we may see a spike up and they probably show that in 1996-1997 we may see a $50 to $100 increase. Senator Rieger said that he had observed that the nominal dollar projections of what was presented by Senator Duncan as the majority plan is different than the nominal dollar projections labeled status quo on this minority report. If percentage are being referred to you are not comparing SB 51 to Senator Duncan's presentation of the majority plans but what was labelled a status quo on an old run. Co-chairman Halford said that it probably depends on the timing of the runs for those small differences. The trend is basically still the same amount of dollars in real value. Senator Steve Frank testified before the committee. In using his charts he stated the majority plan does make more reductions in sending, $250 million in the course of the next five years and we use less tax revenues than the long range financial planning commission. Importantly the constitutional budget reserve is protected and used as an ongoing source of revenue and the permanent fund is protected. No changes are made as to how the permanent fund is handled. No change in the constitution and no change in the dividend. No income tax is required and the bounds of the CBR of the permanent fund are not depleted. Looking at a graphic plan of the majority plan versus the long range financial planning commission plan cuts of $250 million are made by the majority plan over a five year period. If the effect of the long range financial planning commission over five years is looked at, because of their provision for inflation and population growth in the budget, they are actually spending more after the fifth year than we are today. Under our plan once we get down to $250 million in cuts over five years we hold the line. Taxes over the next five fiscal years, the majority plan calls for $281 accumulative taxes over that period of time versus $971 by the long range financial planning commission. One of the primary elements of the majority plan is to conserve the constitutional budget reserve and have the earnings available in an ongoing, sustained basis to help support closing the fiscal gap. The fiscal gap is closed in the fifth year and while doing that the constitutional budget reserve is allowed to grow. Actually there is more in it after the fifth year than today. A graphic example of the declining fiscal gap in relation to the revenues is that revenues are growing slightly due primarily to some new revenues and to increased earnings from the interest on the constitutional budget reserve. This is a further example of how our fiscal gap would be reduced of a five year plan. This can be done primarily through conservation of the constitutional budget reserve, use of earnings from the constitutional budget reserve and the spending cuts. Those are the two primary elements of the majority strategy. Senator Rieger's plan goes more with earnings and budget cuts. The permanent fund is not used in the majority approach. It is simple and does not require a change in the constitution or the dividends. What is asked for is a greater sharing of the revenues from AHFC. That is consistent with what they have agreed to provide. AIDA was asked to share half of their earnings over the course of the next five years and on into the future. Projected earnings are shown by the constitutional budget reserve by asking the permanent fund to manage these funds to increase from about 5% to 7% the rate of return on the constitutional budget reserve where we pick up over $40 million a year. They can manage it over a longer term than they are currently doing in the Division of Treasury. There are new revenues of cigarette, alcohol, motor fuel, plus new development revenues which can go to fill that. That is rather modest in comparison to other plans in terms of new revenue. Going to the expenditure line it shows part of the reduction of $60 million of the $250 million is accomplished through debt service reductions. The capital budget is held constant over those five years. The rest of the items are the supplementals and revised programs. The projected fiscal gap does go down to zero over the next five years and the constitutional budget reserve grows over the course of these five years due to additional settlements. There is widespread agreement on the fact that there will be new settlements. The administration has about $800 million now in projected revenues from the new settlements. The long range fiscal planning commission used $600 million and the majority plan used only $500 million over the course of the next five years. That is a more conservative approach on additional settlements over the next five years. The permanent fund is maintained in its existing status and the future value of the permanent fund is not diminished by eroding the inflation-proofing. The dividends are maintained under the current structure and current law. Even after dropping the additional money into the permanent fund in SB 84 there is still a growing amount of money in the earnings reserve of the permanent fund and an actual growing amount of the excess over and above the amount necessary to inflation-proof and provide for dividends. This plan gets us down to a five year fiscal gap reduction and it does not require a change in the constitution. No income tax is required nor and use of the permanent fund dividend. It does, in summation, require additional relatively modest cuts that require us to tighten our belts. It will not allow government to grow at whatever is convenient and the Legislature will be required to use budget discipline to control expenditures. Co-chairman Halford asked about taxes and new revenues in combination. Senator Frank answered that it is specified as new resource revenues. Hopefully there would be some revenues from some of the incentive legislation passed on oil and mining development. New taxes may be required on partially new revenue development. Co-chairman Halford referred to alcohol and tobacco tax. Hopefully this would be filled in with incentive driven development. Senator Frank concurred. Senator Zharoff asked about protecting the integrity of this majority plan beyond this year. Senator Frank indicated that one of the strengths of this program is that it does not rely on changing the constitution. The people of Alaska have a role in changing the constitution and this program basically follows the people's direction to live within our means. This plan tells the people that it is going to take a modest reduction in the budget over the next five years rather than coming to them for more taxes. Every plan requires that the Legislature pass a budget. The long range fiscal planning commission requires budget reductions. The democrats want some budget reductions. Every plan depends on the Legislature acting responsibly in the future. Co-chairman Halford stated that it looked as if the minority analysis of the majority plan as apparently done by OMB seemed to be showing a different set of results in the long term than expected. What are these differences? Senator Frank responded that one has to keep in mind whether we will be better off in five years under the majority plan or under other plans. The majority plan shows the reserves will be greater. There will be more in our constitutional budget reserve in five years than today. If the permanent fund can be allowed to grow and we can get our spending rate down to a more sustainable rate then we will be better off in five years than today. Future unrestricted revenues do begin to trail off at a faster rate. As the ten year plan is projected out there is still more money in the budget reserve in ten years than today. Some responsibility has been shown by reducing the expenditures and we are better positioned for the future. Senator Phillips commented on the "hub of the wheel". If the Legislature collectively does not follow this strategy the rest of the wheel falls apart. Most people are in the middle column wanting budget reductions. If we don't achieve this everything sort of flies off the wheel, so to speak. Senator Frank concurred. Annalee McConnell, Director, Office of Management and Budget was invited to join the committee. The governor outlined in his State of the Budget speech some principals by which he was evaluating plans and the process we are in now is looking at the elements that have been proposed under various plans their strengths and weaknesses. In the discussion today one can see that there are strengths and weaknesses in each of the plans and it is incumbent on us to figure out as a bi-partisan group, with a lot of public discussion, how to bring these elements together. Some were discussed by Senator Rieger about inflation-proofing, some elements from the Senate minority plan, and one or two from the majority plan are valuable to bring to the table. Another is looking at some higher earnings on the CBR and actually treating the CBR interest as a legitimate revenue stream for the State. That was a concept that Dave Rose advanced. With enough public discussion of all of this a plan could be fashioned both responsible and one that the public would be willing to accept. Senator Phillips referred to a six year plan by the Governor that one of his constituents asked about. Ms. McConnell indicated that the individual from Eagle River may have confused this with the six year capital plan that would be out shortly. The Governor had said that he thought the gap should be closed within no more than six years. Co-chairman Halford asked if the Governor had a plan on the table for a long range fiscal plan. Ms. McConnell advised that he had not set a separate piece of paper on the table. He is looking at all the elements of these plans and also trying to look at some other things like the economic impact of them. She referred to the Long Range Financial Planning Commission's recommendations updated for the fall revenue forecast for some other adjustments. Initially the plan that was out in the commissions report, the newspaper print report, included twelve months of alcohol, tobacco and motor fuels taxes. When the commission did its bills that was translated into nine months for the first year because of the implementation date. There are some tune-ups like that in it. She clarified the number of $140 million shown in the material the senate minority put out which was produced at their request by OMB for the cumulative impact of cuts. That is 1996 dollars and it takes into account the impact of inflation between 1996 and 1997 plus the $70 million in cuts. There has been a fair amount of discussion on what the economic impacts are and in particular the job loss that would be represented by various levels of cuts. Not referring to specific plans they were trying to pull together some summary information from the ISER materials that were presented to the long range financial planning commission. Some rough estimates based on the information that ISER developed in the late 1980's and using their model, a cut of $100 million would produce a combined State, local government and private sector job loss in the neighborhood of 2200 jobs. At the $250 million cut level, it would be about 5600 jobs. The work that David Reaume has done that was referred to earlier, produced some different numbers. One of the recommendations that would be very valuable for Senate Finance would be to bring together some of the folks who analyzed the impacts not only of budget cuts but cuts in dividends and revenue and it would give you an opportunity to question the assumptions they used for the economic multipliers and that sort of thing. One of the major differences that accounts for the wide range in numbers that are produced by economists in this area is their own assumption about where the budget cuts would happen. If you take budget cuts in some areas you have a greater job loss than in others. Cuts in the capital spending area have a less significant job impact on State employment, public, private together than operating. Co-chairman Halford asked about cuts in debt service. Ms. McConnell indicated that cuts in debt service obviously do not have a job loss directed with them. If it is assumed that there will be no new debt issued and the capital budget is to be kept at the level you are suggesting what we will find is that the public will most likely say that we are at an unacceptable level for maintaining our infrastructure let along doing some of the things that have been identified that need to be dealt with such as rural sanitation, getting rid of honey buckets, municipal water and sewer projects, the schools, which have been a great concern for the public, that we are way behind not only in major maintenance of them throughout the State, also the building of new schools. These are some things we think are going to be necessary, no to go back to the days of having lots of capital dollars to spend on nice things, but in terms of what is really essential, the primary kinds of responsibilities for water, sewer, roads, school facilities and dealing also with deferred maintenance which has received more attention at the university level than any other individual level, but is also a serious problem for other state facilities. It would be helpful not only to have some discussions with finance committees, but a chance for the public to hear about this job impact business. Those folks would be happy to come in and talk about the impacts of various types of fiscal tools not just the budget cuts. Senator Frank asked if this is her personal assertion about these impacts on the economy or was she repeating other economists. Ms. McConnell advised that she was repeating a summary of the information from ISER and David Reaume. The ISER information was part of the public record at the commission and she is trying to pull together some things that summarize that information. No independent analysis of job losses had been done. That kind of economic modelling is fairly extensive and at this point there is no need to repeat the work of others. Senator Frank asked if taking the Governor's budget cut at $40 million plus the $70 million you are saying that you would have, $70 million plus $40 million is $110 million, you are saying that your budget would result in 800 to 900 State jobs lost and 100 to 200 private jobs lost as a direct result and so your budget is going to be sending our economy into a tailspin? Ms. McConnell answered no, actually some of the reductions in our budget, like debt service, for instance, offsets some other increases that are in the budget that have to do with formula increases, labor contracts, other increases. It shows that the cumulative impact is more than just the dollar amount of the "nominal amount of a budget cut". Certainly, these figures do not take inflation into account. These are just straight cut figures so inflation would need to be dealt with. A number of changes have been proposed that would deal with them into the future like geographical pay differential. There were conversations last year and again this year on tier three and other things like that which can help in bringing down the rate of growth, welfare reform and medicaid reform. These are being done now in HESS even before there are any legislative changes to bring down the growth rates for those very large drivers in our budget. One is plus inflation and the other is not. There will be some impact. These are the places where the Knowles' Administration proposed to make cuts and the public has a chance to say, "we don't like this" or "these are alright with us". Given that your plan does rest, as Senator Phillips pointed out, on that column of budget cuts that's basically the primary tool, it is going to be very important for people to know how does that primary tool affect them. As long as it is a faceless number, kind of an anonymous budget cut, nobody has any particular reason to say they don't like it. Then you get the more popular thing of saying, "sounds good to me, the budget is going down". Even some of the proposals that we had made in our budget like the income limit on the longevity bonus, for instance, the Legislature is not too inclined to go with those, so what are the alternatives that you are proposing? That's when we will begin to find out if the public feels that the impact of your budget proposal is one that they find acceptable or not. It is very difficult to tell until those cuts are shown. It is exacerbated in a sense because your plan depends twice as much as ours in the next year on budget cuts and that's even more reason why the public needs to know where those cuts would happen. That also affects very much where the job loss would be or how much it would be. Co-chairman Halford said that one of the differences, in particular, is in capital budget. Without the difference in capital budget, the only difference between the majority plan and the plan that you are at least trying to reach in following the commission's recommendation is a total of $30 million. Ms. McConnell stated that the majority capital budget is at $100 million or $110 million for 1997 plus, remember, you are not using AHFC for capital as we had proposed so that adds $20 million more impact. In terms of what is out there on the street in the way of money to do schools, water, sewer, fixing up the pioneer homes, the transportation match for federal funds, as well as some work on corps of engineers problems and airports and so forth, all of that, what you are proposing is to reduce that to $100 million and our current proposal has some money from AHFC. Co-chairman Halford asked how much was the Administration's current proposal. Ms. McConnell replied that it has $110.2 in general fund dollars and $53 million in total AHFC of the portion that usually goes to housing. Senator Halford asked in regards to the Court System. Ms. McConnell replied that the Court System has suggested that they would like $4.5 million for the first three projects on their list. Senator Frank said that the Governor's total capital spending is approaching $600 million. Ms. McConnell advised that it was $660 million with the federal funds and all other miscellaneous funds like university receipts and some things like that which would add up to a total of $660 million. Senator Frank would like to know how that would compare to last year as he would be surprised, even subtracting out $20 million from AHFC and using it in the operating budget where it spends over more times and creates a greater multiplier, our capital budget was actually a reduction over last year. This is relevant because the economic impacts have been brought up. Co-chairman Halford noted that the increase was about $50 million in the capital spending side. Our proposed decrease is $30 million. Senator Frank said that we would actually be spending more under our approach than we did last year, when added to the increased dividends. Any assertion that we are going to have some deleterious effect on the economy is factually incorrect. Ms. McConnell said that it would be important to see where it is proposed to spend capital dollars. What are you planning to put into education or deferred maintenance at the university, or water and sewer or whatever? Senator Frank asked what difference that would make on the economy. Ms. McConnell said that there were two critical impacts: one, what is the impact on the economy, and that is certainly an important effect; the second, what is the impact in terms of meeting the needs that Alaskans have. Senator Frank said that was a legitimate question, but what about reducing the capital budget of AHFC and the economic impacts? Ms. McConnell said that in talking about the capital the concern was on the needs part. Senator Phillips wanted to know the Administration's definition of a "cut" and a "reduction". What is here is a $70 million reduction of which $55 million is actual cuts and there is another $15 million less that we are paying this year than last year on debt. Ms. McConnell pointed out that this was one of the first questions the Governor got in his first public appearance when he released Governor Hickel's budget basically, a year ago December 15, and someone asked him if when he was talking about holding a line on spending was he talking about really holding the line or was there going to be an increase for inflation and then say he was holding the line. The Governor said that he absolutely meant "holding the line". For purposes of saying what is the total impact, that is a very different discussion than what's happening with numbers. We have all been prey to this frenzy about showing budget reductions without thinking about the impacts. When we said we made $35 million in cuts and $5 million more in shifts to fees from general funds we were perfectly up front about saying this is $40 million in these two fashions. The commission had suggested $3 million in fees and $40 millions in cuts and we said we were modifying that to be $8 million in fees and $35 million in cuts for the same mix of the fiscal gap. Senator Phillips asked if she was saying of the $40 million cuts $15 million of it is debt retirement? Ms. McConnell concurred. $15 million is a lower expenditure for debt service than last year, however, it was in the materials presented to you initially. If you are going to talk about the "automatic reductions" the things that happen in spite of you, you also need to point out what the automatic kinds of increases, the things that are happening in spite of you, or the obligations that you have for the future. Contractual obligations, increases in entitlements where we have enrollment increases are shown, but we say that we are not necessarily going to increase the total budget by that amount. We are going to balance things that are cuts some of which happen with or without us and others of which we have to work hard damn hard to accomplish, we balance those with the increases. Senator Phillips stated that he personally was having a hard time to accept $15 million as a cut, a reduction, $5 million in user fees, is that a cut? Most people would say you are taking it out of my pocket, how is that a reduction? Ms. McConnell indicated that it is a shift from general funds support to user support. Senator Phillips indicated that it was the terminology he was questioning. He doesn't view it as a cut. Despite what is done here it is still a reduction, not a cut. Ms. McConnell indicated that she would be happy to call debt service a reduction. Each person brings their own definition of the word. What is important is do we tell the public what we are up to. We told the public that we were doing $35 million in budget cuts and $5 million in shifting from general funds support to user support. What I was trying to do was lay out for the public what it is. We don't know yet how you are proposing to do your $70 million. I think it would be a lot easier to have this conversation about what you propose is a "cut" or "reduction" in your terminology after we see the proposals. Senator Phillips indicated that the Administration had a year to put up their budget, we have been here approximately sixty days and those details will come out a little later on so I just want to understand what your terminology is first before I figure out what you are going to do. (tape SFC-96 # 32 switched to side 2) Co-chairman Halford said that as compared to last year he would congratulate the administration in terms of semantics. Last year's budget was a cut that spent $160 million more and hired hundreds of new state employees. This year instead of having $160 million increase on the table at the starting point, even if the proposed changes are not really cuts, they probably would get us down to last year's starting point. In comparison to the first year we are ahead by something close to $160 million at the starting point. That is getting us closer to whether it is your $35 million by your calculation or it is our $70 million by our calculation, the differences are no where near what people are talking about and what we were dealing with last year. Ms. McConnell indicated that one should get away from all the focus on numbers, not that numbers aren't important, but in terms of not looking at what's behind it. For instance, the largest number of increases in employees between 1995 and 1996 was for child support enforcement, which is mostly federally funded. It is very deceptive to tell the public we added hundreds of employees. The public should be told more about what is being accomplished by the dollars that are being spent. Some progress has been made both within the administration and between the administration and the Legislature in trying as much as possible to get towards using similar or the same numbers, showing things the same way, showing the supplementals, and we knew that there would have to be some supplementals for judgments, for fires and disasters, showing those up front. Co-chairman Halford indicated that it is not so much what we say to them, but rather what they believe. They do not believe that we are cutting the budget if we have more employees and if the number is higher, and they get confused in general funds versus all funds and all the other categories. The eventual result is that if the number at the bottom of it all is higher, as it is in capital for example, they consider that as spending increase regardless of the sources. They simplify all of our insider arguments in a lot of incorrect terms. Ms. McConnell said that it is our job to try to work to get away from some of that. It is very unfortunate the way we show our numbers now, mean that things that are fully fee supported, if that increases, and the public wants that increase, that works against us in terms of what happens on the bottom line. That doesn't make a lot of sense. We have boards and commissions that say they would like to spend more money to do X, Y and Z, they are happy to increase their own fees they assess on themselves to pay for it, and yet there is this pressure not to do those kinds of increases because it doesn't show as a budget cut. We do have a lot of work ahead of us to try and simplify all of this and recognize that the public certainly doesn't have any time to sort through all that stuff. One of the clarifications that would be helpful in terms of looking at the majority plan is what is the expectation after five years in terms of whether there would be any allowance for any growth in either population or acknowledgement of inflation. There has not necessarily been a determination of what would be something that would help us in taking a look at the long term impacts of the various proposals that are on the table. Senator Frank said it would have been more appropriate if she would have said that she was making her assumptions about what the majority plan was rather than just putting out a piece of paper with majority on it. Ms. McConnell advised that she incorporated those at the request of the minority to show the assumptions they noted on their materials. She asked what other title would have been more appropriate. Senator Frank said that their plan does not assume any particular course of action into the future. If you let the budget grow at an amount that recognizes inflation or part of inflation or the population, obviously you will spend more money. We can't really tell what the public's really going to want in those years until we see what happens. If we hold the line for a ten year period or if we let the budget grow by a percentage point or so over the course of the additional five years, in our plan, you still wind up with more money then than you have today in reserves. It is certainly a legitimate question and the further out you get in your projections the less certainty there is obviously. The thing that is going to matter the most is what happens to oil revenues because it will still be the biggest component of any of our plans and a couple of dollars price change in oil or any kind of change in the production rate makes more difference than any of the other assumptions. Let us get our spending more under control now in the time period that we do have control over it and set ourselves up for a better positioning in the future rather than just sustaining the level of government we have now and allowing it to grow in the future. Ms. McConnell indicated that the commission spent quite a bit of time in dealing with the issue of what would be an appropriate amount to assume for growth after the period of the initial budget cuts. Some further modifications of the commission recommendations makes sense. Not all programs were population driven and certainly if you double the population of the State of Alaska you would not necessarily end up with 120 legislators, two governors, or two OMB directors, etc. On the other hand programs like education and other formula programs are certainly population driven, as are many other things that are a little bit more indirect. The commission chose to use half of population as an assumption for growth, plus inflation for the future. It would be very helpful to get some sense of what does the Legislature and the Administration feel would be appropriate to work with for the future about assumptions for growth. Not everybody is necessarily going to agree on all of it, but if at least we were to come to some conclusion about roughly what percentage of our state expenditures are population driven that in itself would be a useful thing to get some consensus on. Senator Frank said he did not know about the Governor's plan because it was not on the table but the long range fiscal plan has the budget growing more in the next decade than it has in the previous decade. The people of Alaska are not happy with the fact that we have not done a better job in reducing expenditures and living within our means. Not only have we not reduced it since the budget crisis in the mid 1980's we have actually allowed it to grow, albeit at a much lesser rate than inflation and our population increases would indicate. The long range fiscal planning commission assumes a growth rate in the next decade more than we have had in the last. Maybe we could come to some agreement on what rate of growth we should allow or not allow in the future and that may be a very appropriate debate and it may not change our need to get our spending under control in the present, but it certainly would be a good exercise for long term assumptions. Ms. McConnell indicated the commission's report does not change the growth rate in the future, however, the cumulative impact is larger if the population is increasing at 1.6% Cumulatively it becomes a larger number of people out in the out years than at the beginning and the same with inflation but the growth rate assumption was the same throughout the fifteen year period. Senator Frank said that it results in more money being added to the budget in the next decade, more than we've had in the last decade. Ms. McConnell indicated that the irony is that the public understands very well the impacts of growth and inflation in their own budgets. The public does not think that in their own family budget with three children can be the same as it was with just two adults or that the total grocery bill is going to be the same in 1980 and 1996. Somehow when we move up to the level of billions of dollars people lose track of that and there is no longer that kind of gut sense that it makes sense to recognize and acknowledge the impact of inflation and population growth. Senator Frank indicated that some people have had to deal with actual cuts in their pay and actual reductions in their income. Some people have to accommodate another child with no increase in their income and that is the kind of criticism that we are getting. The public is saying that they have tightened their belt but the government is spending more today than a decade ago. That is where we get into a rub with what the people of Alaska want. The people want us to control the growth of government and State spending and maybe others don't believe that. Maybe that is a philosophical debate we will never get past. Ms. McConnell said that maybe it depends on what one is talking about. The longevity bonus program, for instance, has had mail on both sides of that issue, saying the Governor's proposal did not go far enough because clearly $60,000 is way more than anybody needs to get $3,000 more. People have also said they do not like it. In different program areas there is not going to be consensus in the public let alone a smaller group of the Legislature. That is what this whole budget process is going to be about. Co-chairman Halford said there would be resistance in the administration if the Legislature proposed that any tax increase had to be approved by the voters. Ms. McConnell said that the Governor had already indicated that he supports the idea of a motor fuel tax which would go to the voters so that is not a blanket statement that there would be opposition to all taxes going to the voters. He has already said he thinks there is one that should to the voters. Senator Frank said that he would like to echo the remarks of Co-chairman Halford with regards to the Governor and his budget. It is appreciated that it is less this year than it was last year and there is less money on the table for spending than the previous year. Co-chairman Halford voiced concern over the question of some funding mechanism for major capital projects in education and corrections. There are rumors but no proposal. What is the status of those two areas in particular? Ms. McConnell said it should be out relatively soon, however the proposals will not be completely finished in a couple of areas. The board of education is working on the whole capital construction area, both major maintenance and new construction. This work is not going to be finished until in time for next year's session. We are going to put at least a view of how much money we think at a minimum should be dedicated toward education facilities over the next years but the mechanism of how that might be allocated may change depending on what the board of education works with. This will still be work in progress. Co-chairman Halford asked if they had all the pieces of the spending plan that the administration was going to propose this year at this time? I've heard some interest in corrections and education. Ms. McConnell advised that the Governor will be announcing his corrections plan on Monday so there will be some additional information that can be used in the process. Co-chairman Halford asked about education and was there a proposal. Ms. McConnell said that obviously in the capital budget we have proposed $7.5 million for major maintenance and school construction. Six or seven schools for major maintenance and one for construction. Senator Zharoff said he was concerned about the jobs and the potential impact that was going to have. Rough calculations show that under the $35 million reduction anywhere from 500 - 750 jobs could be affected from the State, private and other sectors. That is a big question as to whether those reductions are going to have an impact on the State. As you go from the $35 million you can kind of go up to $70 million and then you can double all that and you can go to the $250 million over a five year period, but it would be good to have some idea of the impact of those jobs and where they are going to be. Senator Phillip commented that he felt we were going to have various views from the economists just like one's view of the world. Senator Halford and Senator Zharoff concurred, but Senator Halford said that we also needed to concentrate on the question and kind of narrow it down because we have lived for years being able to export our tax burden or essentially spend our natural resource wealth for all generations of Alaskans. Those are easy ways to make the now economy work but if we get down to the point where it is choosing to tax the private sector to support the public sector and taking the same dollars out of the private sector jobs and putting them in public sector jobs maybe we have an economic negative. That is the bottom line and that question needs to be asked in pretty specific terms. Ms. McConnell indicated that there were some things that the administration was working on very aggressively that would help in that area and it is not so much budget related, but working with industry, for instance, to get more of the jobs Alaskanized and not all of that conversation is dependent on the budget. Certainly a lot of it is but there are a lot of other things we are trying to do simultaneously to try and deal with much of that and get the income back in the State where it does us more good. Co-chairman Halford referred to the motor fuel tax. It is paid for all by Alaskans and if it generates $50 million for State government in some round number and it takes $50 million out of the private sector pockets of Alaska citizens, have we increased the economy or have we reallocated away from areas with high fuel costs, high fuel use, into government centers. That is the question we need answered. ADJOURNMENT The meeting was adjourned at approximately 11:50 A.M.