MINUTES FIRST SPECIAL SESSION SENATE FINANCE COMMITTEE May 24, 1999 1:03 PM TAPES SFC-99 SS1 # 2, Side A CALL TO ORDER Co-Chair Torgerson convened the meeting at approximately 1:03 PM. PRESENT Senator John Torgerson, Senator Sean Parnell, Senator Pete Kelly, Senator Randy Phillips, Senator Gary Wilken were present when the meeting convened. Senator Al Adams, Senator Loren Leman, Senator Lyda Green and Senator Dave Donley arrived shortly thereafter. Also Attending: Senator RICK HALFORD; Senator JERRY MACKIE; Senator JOHNNY ELLIS; BRAD PIERCE, Senior Policy Analyst, Office of Management and Budget, Office of the Governor; PAT POURCHOT, Legislative Director, Governor's Legislative Office, Office of the Governor; GAIL FENUMIAI, Election Program Specialist, Division of Elections, Office of the Lieutenant Governor; PHIL OKESON, Fiscal Analyst, Division of Legislative Finance. SUMMARY INFORMATION HB1001-ADVISORY VOTE LONG-TERM FINANCIAL PLAN The Committee adopted a committee substitute, rejected one amendment, adopted a conceptual amendment and moved the bill from committee. CS FOR HOUSE BILL NO. 1001(FIN) am "An Act relating to income of the Alaska permanent fund and authorizing an advisory vote on a long-term financial plan for the state; and providing for an effective date." Co-Chair John Torgerson had a committee substitute for HB 1001, 1-LS1022/S, 5/24/99 drafted that was before the members. The committee substitute read as follows: Section 1. ADVISORY VOTE. At a special election to be held on September 14, 1999, in substantial compliance with the election laws of the state, including absentee voting and the preparation, publication, and mailing of an election pamphlet under AS 15.58.010 - 15.58.090, the lieutenant governor shall place before the qualified voters of the state a question advisory to the legislature and the governor. The election pamphlet for the special election must comply with AS 15.58.020(6), including the requirement that it contain statements that advocate voter approval or rejection of the question. Notwithstanding AS 15.60.005 and other laws relaxing to preparation of the ballot proposition, the question shall appear on the ballot in the following form: QUESTION Preamble: The people of Alaska created the Alaska permanent fund to save a portion of Alaska's petroleum revenue for the future. After investing those savings, the original intent and purpose was to then use the earnings from those investments when Alaska's petroleum revenues declined. Petroleum revenues have now declined substantially and ate forecast to continue to decline. Our reliance on declining oil production and volatile oil prices constitutes an unsustainable budget system. The governor and the legislature seek the public's judgment in adopting a stable and sustainable long-term balanced budget plan. Balanced Budget Plan: This will preserve the permanent fund dividend, inflation-proof the Alaska permanent fund, support public services, and establish a Citizens' Balanced Budget Task Force. Please mark "yes" or "no" on this plan. The Balanced Budget Plan will (1) Spending Reductions: Continue state general fund budget reductions to a combined total of at least $60,000,000 for fiscal years 2000 and 2001. Submit a proposed constitutional amendment to the voters that would reduce the base amount of annual appropriations in alt IX, sec. 16, Constitution of the Stale of Alaska, and make other changes to establish a meaningful appropriation limit. (2) Permanent Fund Protection: Guarantee the Alaska permanent fund principal is untouched. The principal of the fund is inflation- proofed to protect its value for all Alaskans, including future generations. (3) Permanent Fund Dividends: Guarantee a dividend is paid to qualified Alaska residents at a minimum of $1,700 in 1999 and $1,700 in 2000 and, thereafter, approximately $1348 and higher. Beginning in 2001, the constitutional budget reserve and the permanent fund earnings reserve will be combined. In determining the market value for the calculation of the dividend, this new account will be joined with the principal of the Alaska permanent fund. After accounting for inflation- proofing, the dividend will be based on 50 percent of the annual earnings payment of these combined accounts. (4) Earnings Reserve Usage for Public Purposes: After payment of permanent fund dividends and inflation-proofing the fund, the remaining annual earnings payment will be prioritized for usage for education, public safety, and transportation. (5) Accountability: expenditures from the combined account will be fully disclosed on each annual permanent fund dividend check. (6) Balanced Budget Task Force: Establish a Citizens' Balanced Budget Task Force to present options to further reduce state spending and identify appropriate future revenue sources. (7) Income Tax: No income tax on individuals will be required as part of this plan. After paying annual dividends to residents and inflation-proofing the Alaska permanent fund, should a portion of permanent fund investment earnings be used to help balance the state budget? Yes( ) No( ) Sec. 2. This Act takes effect immediately under AS 01.10.070(c). Senator Sean Parnell moved for adoption of the committee substitute for as a Workdraft. Co-Chair John Torgerson explained the primary differences between the committee substitute and CS HB 1001 (FIN) am, the version referred to the Committee. Co-Chair John Torgerson stated that the committee substitute strips from the House version, the statutory changes that would enact a plan. He stated that the only language retained from the House version is the advisory vote portion, beginning on page 4 line 5 of the House version. The remainder of the bill is deleted. He noted that the advisory vote language is identical to the language that was amended the previous night on the Senate Floor with the following exceptions: Page 1 lines 6 and 7 of the committee substitute inserts into Section 1, "and the preparation, publication and mailing of an election pamphlet under AS 15.58.010 - 15.58.090," before, "the lieutenant governor shall place before the qualified voters of the state a question advisory to the legislature and the governor." The committee substitute next inserts a new sentence into Section 1 on Page 1 line 9. This sentence states, "The election pamphlet for the special election must comply with AS 15.58.020(6), including the requirement that it contain statements that advocate voter approval or rejection of the question." Page 2 line 6 of the committee substitute replaces "upon" with "on" in the preamble language. The sentence now reads, "Our reliance on declining oil production and volatile oil prices constitutes and unsustainable budget system." Also in the preamble language, on Page 2 line 7 of the committee substitute, the word, "state" is removed from in front of the word, "legislature". The sentence now reads, "The governor and the legislature seek the public's judgement in adopting a stable and sustainable long-term balanced budget plan." Co-Chair John Torgerson commented that "state" was removed during drafting because it was deemed unnecessary. On page 2 line 10 of the committee substitute, "Alaska" is inserted before "permanent fund". This sentence in the preamble now reads, "This will preserve the permanent fund dividend, inflation-proof the Alaska permanent fund, support public services, and establish a Citizen's Balanced Budget Task Force." Co-Chair John Torgerson explained that this addition better clarifies the permanent fund. On page 2 line 13 of the committee substitute, in the first descriptive paragraph of the balanced budget plan, the word, "to" replaces the word, "for". The sentence reads, "Continue state general fund budget reductions to a combined total of at least $60,000,000 for fiscal years 2000 and 2001. On page 2 line 28 of the committee substitute, in the third descriptive paragraph, "Alaska" is again added before, "permanent fund". The sentence now reads, "In determining the market value for the calculation of the dividend, this new account will be joined with the principal of the Alaska permanent fund." On page 3 line 9 of the committee substitute, in the seventh descriptive paragraph, the word "personal" is deleted and the word, "individuals" is added. The sentence now reads, "No income tax in individuals will be required as part of this plan." On page 3 line 11 of the committee substitute, "Alaska" is once again added in front of, "permanent fund". This sentence reads, "After paying annual dividends to residents and inflation-proofing the Alaska permanent fund, should a portion of permanent fund investment earnings be used to help balance the state budget?" Senator Randy Phillips noted that throughout the committee substitute, the words "permanent fund" are not capitalized. He questioned whether they should be capitalized. Co-Chair John Torgerson was unsure and said he would ask the Division of Legal and Research Services to advise. Senator Randy Phillips stated that he wanted it capitalized. Co-Chair John Torgerson offered to take a half-hour recess to allow members to review the committee substitute. Senator Sean Parnell commented that the Committee had voted on this language in the form of past legislation. Senator Dave Donley wanted discussion. He commented that this particular plan had been developed, and he understood the public policy arguments for doing so. He assessed that this plan proposes to base dividends on the value of the corpus of the permanent fund for the first time rather than on earnings. One of the advantages of calculating the dividend on a fixed percentage of the corpus, in his opinion, is that the dividend amounts can be predicted. However, he believed there were disadvantages to this calculation method, which had not been discussed in the Committee. He remarked that the disadvantage is that this method removes the linkage between the investment policy of the fund and the payment of dividends. He commented, "As it is now, the better the investment the better the return, the higher the dividends." He warned that to change to a fixed percentage of the corpus, most of the linkage is removed. Co-Chair John Torgerson interrupted saying the dividend calculation is based on the total market value on not only the principal, but also on the earnings reserve. Senator Dave Donley conceded, but noted that most of the linkage is still removed from the investment policy and the payment of the dividend. Co-Chair John Torgerson rebutted, saying that as the fund increases, even though the percent is fixed, the "pot gets bigger." Senator Dave Donley said that would be miniscule compared to the existing correlation. He was careful to say that not all of the linkage would be removed, but felt that about 95-percent would be removed. Senator Dave Donley was interested in having a general discussion in the Committee on the pros and cons of switching to a value of the corpus method of dividend calculation. He referenced the strong political incentive in insuring the highest dividend return under the current system. At the same time, he noted the restraint exercised in limiting the types and encouraging the diversity of investments for the fund to preserve the corpus and to protect the income stream. However, he cautioned that much of the political incentive would be jeopardized by changing to a calculation of the dividend based on a fixed percentage of the total. He wanted to know how the other members felt about the loss of linkage. Senator Gary Wilken noted that when the process began earlier in the session, he was one who felt the dividend calculation should be linked to earnings. He spoke of the positive market over the past decade and how he would like that to continue. However, reality has led him to become comfortable with the market value approach. One reason he cited is learning that other large capital accumulations similar to the Alaska permanent fund have already converted to some type of market-value approach. He took the lead of those before him and supported the market value approach. Senator Loren Leman said one of the things he found attractive about calculating dividends from a percentage of the entire fund is that it removes one of the obstacles from the fund managers regarding realized earnings when a stock is sold off. He pointed out that when assets are sold, the dividends are driven up artificially. This removes that obstacle and makes it easier for fund managers to "do the right thing management-wise" and give managers better flexibility to make decisions based on the best interest of the permanent fund, in his opinion. He partially agreed with Senator Dave Donley that the calculation changes reduces some of the linkage to the earnings, but felt that it did not remove all of the linkage and the corpus-plus-earnings will remain. He believed people would still find the proposed calculation method necessary to protect the entire fund. He hoped people would still feel the fund is a valuable asset to protect for the future. He studied the change in calculation and determined it is a reasonable thing to do. Senator Sean Parnell did not think there would be a loss of linkage in going to the market value approach because the dividend is still linked to the market value of the total fund. Therefore, he concluded that as the total fund increases due to good management decisions, the dividend would also increase. He noted the Committee had also heard from Callan and Associates and the managers of the permanent fund, who testified that basing dividends on realized earnings is a more risky investment to both the dividend and the permanent fund itself. He reminded the members that they had held numerous discussions on this point. He stressed that the Alaska permanent fund is one of the few remaining funds that continue to calculate dividends on realized earnings rather than on the market value of the fund. The current calculation is an obsolete investment method and invites more risk, in his opinion and according to the expert's advice. He cautioned that this extra risk should not be taken with the permanent fund or the dividend. Senator Gary Wilken agreed that people do plan on the dividends as part of their income and that the need for the higher amounts could be argued. However, he noted that the fund had some years of flat earnings in which the dividends were smaller. He realized that the current "five-year averaging" system would prevent drops in dividends caused by one bad year, but warned that if the market were poor for three or four years, the dividends would shrink. He felt that for Alaskan's who are planning on the money, the market value approach equals out the highs and the lows. Senator Dave Donley appreciated the discussion. He felt there were good points either way. However he stressed there are differences between private sector policy and public sector policy and he believed the private sector policy is superior. In the private sector, he explained, there is not the temptation or the need to spend some of the money on other things. He felt this was the reason the original dividends were related directly to the earnings of the fund rather that the spending desires of the large special interests who wished to tap the fund. Senator Pete Kelly added to Senator Gary Wilken's last comments saying that in certain unfavorable market conditions, the dividend would not only shrink, but would actually disappear. However, he believed that the market value system ensures the ability to ride out tough markets for much longer periods of time than under the current system. . Senator Gary Wilken didn't think any changes to the method of calculating the dividend would change the mandate of the permanent fund. The board would still operate under the same mandate of maximum return with preservation of capital being the number one priority. Therefore, it seemed to him that the fund would continue to be managed with the same goal. Co-Chair John Torgerson clarified that the permanent fund managers follow the "Prudent Investor's Rule." Senator Dave Donley agreed it is correct that the change would not affect the investment policy. However, he thought that it would remove the immediate impact of shifts in investment policy from the dividend and would therefore distance the policy from the public's direct linkage to that policy. He stated that currently, a change in policy would result in a direct impact on the dividend. Senator Al Adams pointed out that in analyzing a market value approach, the Committee has only relied on the Commissioner of the Department of Revenue's assessment using only an 8.13 percent rate of return could be used. Senator Al Adams asked how many corporations actually realized that high of a rate of return and he disagreed that the average rate of return for the permanent fund would be that high. He surmised the Administration had bent to political pressure to allow the use of the highest rate of return. He then criticized the use of the 2.25 percent formula used for inflation proofing the permanent fund and the intent to give 5.88 percent to the general fund. He thought the Committee was wrong in assuming that high rate of return would result in averaged higher dividends. He speculated that the dividends would not be as high as predicted. He warned that using this formula was playing a dangerous game. Co-Chair John Torgerson suggested that would be an interesting discussion to have with the permanent fund managers, Callan and Associates and the other experts advising the legislature on this matter. He countered that the figures the Committee is using came from outside experts; the Committee did not come up with the theory itself. Senator Gary Wilken restated Co-Chair John Torgerson's argument saying that today the 30-year long-bond earning is 5.87 percent. Therefore, he suggested that the permanent fund could invest solely in long-bonds and only need to earn 2.26 percent more to reach the projected 8.13 percent used to calculate the earnings under this plan. He summarized that 8.13 in the historic market is not an unreasonable rate of return. Co-Chair John Torgerson thought Senator Al Adams's was referring to the average over time. Senator Al Adams only wanted the Permanent Fund Division experts to address the matter before the Committee and either dispute or agree with the statements made by the Commissioner of the Department of Revenue. He felt the Commissioner bent to political pressure. Senator Al Adams then referred to his proposed amendment. Amendment #1: This amendment changes the ballot language of the advisory vote to read as follows: QUESTION Preamble: The people of Alaska created the Alaska Permanent Fund to save a portion of Alaska's petroleum revenue for the future. After investing those savings, the original intent and purpose was to then use the earnings from those investments when Alaska's petroleum revenues declined. Petroleum revenues have now declined substantially and are forecast to continue to decline. Our reliance upon declining oil production and volatile oil prices constitutes an unsustainable state budget system. The governor and state legislature seek the public's judgement in adopting a stable and sustainable long-term balanced budget plan. Balanced Budget Plan: This will preserve the Permanent Fund dividend, inflation-proof the Permanent Fund, support public services, and establish a Citizen's Balanced Budget Task Force. Please mark "yes or "no" on this plan. The Balanced Budget Plan will: 1. Spending Reductions: Continue state general fund budget reductions for fiscal years 2000 and 2001 and establish a Citizen's Balanced Budget Task Force to identify options to further reduce state spending and explore future revenue sources. 2. Permanent Fund Protection: Guarantee the Alaska Permanent Fund principal is untouched. The principal of the Fund is inflation-proofed to protect its value for all Alaskans, including future generations. 3. Permanent Fund Dividends: Guarantee a dividend is paid to qualified Alaska residents at a minimum of $1,700 in 1999 and $1,700 in 2000 and thereafter, approximately $1,348 and higher. Beginning in 2001, the Constitutional Budget Reserve and the Permanent Fund Earnings Reserve will be combined, which requires a three-quarter vote of the House and Senate. In determining the market value for the calculation of the dividend, this new account will be joined with the principal of the Permanent Fund. After accounting for inflation-proofing, the dividend will be based on 50% of the annual earnings payment of these combined accounts. 4. Earnings Reserve Usage for Public Purposes: After payment of Permanent Fund dividends and inflation-proofing the Fund, the remaining annual earnings payment will be used for essential public services. 5. Accountability: Expenditures from the combined account will be fully disclosed on each annual Permanent Fund Dividend check. 6. Income Tax: No personal income tax is required as part of this plan. Question: After paying annual dividends to residents and inflation-proofing the Permanent Fund, should a portion of Permanent Fund Investment Earnings be used to help balance the state budget? Yes( ) No( ) Senator Al Adams moved for adoption. Co-Chair John Torgerson objected. Senator Al Adams spoke to the amendment detailing the changes it makes. The amendment deletes the provision in the first descriptive paragraph, stating that the general fund budget will be reduced by the set amount of $60 million for fiscal years 2000 and 2001. The amendment also deletes the provision in the first descriptive paragraph, calling for a proposed constitutional amendment to reduce the base amount of annual appropriations. Senator Al Adams referred to legislation, SJR 24, being considered in the Senate Judiciary Committee that proposes a similar constitutional spending limit. He speculated that the other body of the legislature would not pass a constitutional amendment in this manner. Therefore, he questioned why the provision is included in this bill. The amendment also restates in the first descriptive paragraph, the provision calling for the establishment of a Citizen's Balanced Budget Task Force. Senator Al Adams pointed out that the task force is stipulated in the preamble language of the ballot, and is now added in the description as well. The second descriptive paragraph of the advisory vote ballot language is unchanged by this amendment. The amendment inserts language in the third descriptive paragraph following, "Beginning in 2001, the Constitutional Budget Reserve and the Permanent Fund Earnings Reserve will be combined." The new language adds, ", which requires a three-quarter vote of the House and Senate." The amendment changes part of the last sentence in the forth descriptive paragraph, which dictates that the remaining annual earnings payment "will be prioritized for usage for education, public safety and transportation." New language is inserted to read, ".will be used for essential public services." Senator Al Adams's testified that Alaskans in his district depend heavily on services in addition to just education, public safety and transportation. The fifth descriptive paragraph of the advisory vote ballot language is unchanged by this amendment. The amendment deletes the sixth descriptive paragraph. Senator Al Adams noted that the main difference in this amendment is the absence of a constitutional spending limit. However, he questioned the results shown in the public opinion polls, suggesting that polls can be written to garner particular results. He thought the people would recognize that a constitutional spending limit is not needed. He also recognized that the other body would not pass a constitutional amendment on this plan. Co-Chair John Torgerson stressed that this advisory vote does not institute a constitutional amendment for either voters or the other body. Senator Al Adams agreed but noted that any time a proposal is submitted in an advisory vote, people expect that action to be taken. He did not think a constitutional amendment should be adopted and that spending limits could be instituted by the legislature itself without the language in the advisory vote. Co-Chair John Torgerson stated it is his intent to work toward the goal of adopting a constitutional spending limit. Therefore, he was comfortable with the language on the ballot. Senator Randy Phillips pointed out that, assuming this bill passes the legislature, the governor approves an advisory vote and the voters adopt the options, the legislature could always return and draft a constitutional amendment. However, he qualified that the voters would still have to approve that amendment. Because constitutional amendments are allowed on the ballot only during general elections, he stressed that an amendment could not be adopted this year. He commented on the spending reductions, saying he felt that the public should be advised of the amount of reductions to the general fund operating budget. Senator Sean Parnell noted that when the idea of tapping the permanent fund account was first mentioned, the feedback he received was that the public wanted some assurance that the spending would be limited. He believed that the only way to ensure the limitations is through a constitutional amendment. Without language promising a constitutional amendment included in the advisory vote, in his opinion, the voters would have very little confidence or reason to believe that there are limitations on spending from funds coming from earnings of the permanent fund. Senator Al Adams argued that if that was the case, there should be a separate question on the ballot to address the spending limitations. Most voters would only see the dividend reductions, he surmised. The amendment FAILED to be adopted by a vote of 1-8. Senator Al Adams voted in favor. Senator Al Adams objected to the adoption of the committee substitute as a Workdraft. By a vote of 8-1, CS HB 1001 was ADOPTED. Senator Al Adams cast the nay vote. Senator Randy Phillips restated his desire to have "Alaska Permanent Fund" capitalized. Co-Chair John Torgerson agreed to direct the bill drafters to incorporate this request. The bill was reported out of Committee by a vote of 8-1. Senator Al Adams voted in opposition. ADJOURNED Co-Chair Torgerson recessed the meeting to the call of the chair at 1:37 PM. Co-Chair Torgerson adjourned for the day at 5:35 PM. SFC-99 SS1 (14) 5/24/99