160108 gunnar knapp-an introduction to alaska fiscal facts and choices-january 8, 2015 02(1)(1)

1

An Introduction to

Alaska Fiscal Facts and C

hoices

Gunnar K

nappD

irector and Professor of E

conomics

Institute of Social and E

conomic R

esearchU

niversity of Alaska A

nchorageG

unnar.Knapp@

uaa.alaska.edu

January 8, 2016

ISER publications and presentations are solely the w

ork of individual authors and should beattributed to them

, not to ISER, the U

niversity of Alaska Anchorage, or the research sponsors.

Alaska’s faces an extremely serious fiscal challenge.

We are spending m

ore than twice as m

uch as our revenues.W

e are paying for the deficit by drawing dow

n our savings.

2

We can’t continue to run huge deficits like this year’s.

We don’t have enough savings.

3

In the next few years,

we w

ill haveto close the funding gap

between our spending and our revenues.

We w

ill have to make big changes

in what w

e spend or how w

e pay for it—or both.

4

From 2005 to

2014, oil revenues

averaged 90% of

Alaska’s “unrestricted general fund revenues”

(which pay for

state governm

ent).

Alaska has been extremely dependent on

oil revenues to fund state government.

5

6

Our state revenues are extrem

ely sensitive to oil prices—

particularly at prices above $80/barrel.

Oil prices have fallen drastically over the past year and a half

—and are continuing to fall.

7

The price was

$34/barrel onJanuary 5

ProjectedH

istorical

$7.8 billion drop in oil revenues from

2012 to 2016

(88% drop)

Mostly because of the fall in oil prices, our oil revenues have fallen drastically.Falling oil production and higher costs and credits have also played a role.

8

From 2005

to 2012 oil prices and revenues

rose dram

atically

In just four years,m

ost of the money w

e had been using to pay for state governm

entevaporated.

It’s gone.

That’s why w

e have a big problem.

Won’t oil prices go back up and save us?

•It happened in the early 2000s w

hen we faced a sim

ilar fiscal challenge.•

It could happen again.

•But it probably w

on’t.–

There is a glut of oil on world m

arkets

•M

ost oil market analysts think prices w

on’t rebound above $70-$90/barrel, because–

So much oil production is profitable at those prices

–G

rowth in w

orld oil demand is slow

ing

10

Hoping that oil prices rise is not a realistic

or responsible solution to our fiscal challenge.

Even if oil prices rise, our oil revenues will decline

as oil productionfalls.

11

From 2005 to 2012, even though spending w

as rising, w

e ran big General Fund surpluses. S

ince 2013 we

have been running big General Fund deficits.

ProjectedH

istorical12

We used the surpluses prior to 2012 to build up our savings reserve.Since 2013 w

e have been rapidly drawing dow

n our reserves.C

ontinued deficits of this year’s level could drain our reserves in 2 years.

13

ProjectedH

istorical

This year’s (FY16) projected deficit is huge.

FY16 unrestricted

general fund spending

$5.2 billion

$3.6 billion(69%

of spending)

$1.6 billion

Projected deficit

Projected

revenues

$7,100per A

laskan

$4,900per A

laskan

$2,200per A

laskan“P

er Alaskan”

figures are based on 2014 A

laska population estim

ate of 735,601.

How

we are spending $5.2 billion in FY16

1,247 (96%) is

K-12 form

ula

641 (55%) is

Medicaid form

ula

Trends in General Fund spending, FY07-FY16

16

The Perm

anent Fund is worth m

ore than $50 billion.M

ost of the value is in the principal, which w

e can’t spend.W

e can only spend the “realized earnings” in the earnings reserve,w

hich are currently about $7 billion.

17

The Permanent Fund earns billions of dollars in m

ost years,w

hich go into the earnings reserve.

18

Every year, w

e take money out of the earnings reserve to pay for

dividendsand inflation proofing.

19

In most recent years the Perm

anent Fund has earned more than w

e have used for dividends and inflation proofing—

so we have been retaining som

e earnings and the earnings reserve has been grow

ing.

20

Like oil revenues, Permanent Fund earnings are highly variable—

but they have been grow

ing as the Fund grows. For the past tw

o years they have been m

ore than our oil revenues.

ProjectedH

istorical

HO

WW

ILL WE FILL TH

E FUN

DIN

G G

AP?

Our only significant and practical options are som

e combination of:

Spending cutsN

ew revenues

Using Perm

anent Fund earnings

There are no easy choices.

The funding gap is so large thatw

e will probably need to use allof these options.

22

The challenge with spending cuts is figuring out w

hat to cut that isn’t m

andated, essential or “penny-wise but pound-foolish.”

Very little capital

spending is left to cut

It would be

very difficult to cut debt &

retirem

ent spending

Cutting oil tax

credits could affect future production

and revenues

Most cuts w

ould have to come from

state agencies—

including education&

health

There are many potential options for new

state revenues—

but none would be enough to close the funding gap.

Alaskans pay m

uch lower broad-based state taxes

than residents of any other state.

Alaska

25

Using Perm

anent Fund earnings would require som

e combination of:

-Reducing Perm

anent Fund dividends-R

educing inflation proofing-

Adding less to the Earnings Reserve

-D

rawing dow

n the Earnings Reserve

How

would different options for closing the fiscal gap affect

Alaska’s economy and Alaskans?

Option

Effect on the economy

Who w

ouldbe m

ost affected

Cutting

spendingFew

ergovernment jobs &

income

Fewer contractor jobs &

income

Multiplier effects of low

er spending by governm

ent & contractor em

ployees

Governm

entemployees

Contractor em

ployees

Trade and service industry businesses & em

ployees

Beneficiaries

of governm

ent services that are cut

How



Option


Who w

ouldbe m

ost affectedIncom

etaxes

Sales taxesLess personal incom

e


er spending by households

Richerfam

ilies (income taxes)

All families (sales taxes)


ployees

Resource

industry taxesLess business

income

Fewer resource industry

jobs


er spending by resource industry businesses & households

Resource industry businesses

Resource industry fam

ilies


ployees

How



Option


Who w

ouldbe m

ost affected

Cutting

dividendsLess personal incom

e


er spending by households

All families

(The relative effects would be

greatest for poor families &

large families)


ployees

How



Option

Effect on the econom

yW

ho would

be m

ost affectedC

uttingPerm

anent Fund inflation proofing

Adding less to or drawing

down the Perm

anent Fund earnings reserve

No im

mediate effect

Slower Perm

anent Fund grow

th

Lower future

Permanent Fund

earnings

Future Alaskans

WH

ENW

ILL WE FILL TH

E FUN

DIN

G G

AP?

The more gradually w

e adjust,the sm

aller the imm

ediate direct effects on the economy.

But the longer we delay:

The bigger the future direct effects on the economy.

The greater the risk of forced drastic adjustments .

The greater the risk to investor confidenceThe greater the risk to our credit rating

The lower our future investm

ent earningsThe less savings w

e leave for future generations

31

Our incom

e-W

hat we add to our savings

+ What w

etake out of our savings

= What w

e can spend

33

Over any period of tim

e what w

e can spend is constrained by our incom

e and w

hat we add to or take out of our savings.

Four key choices that we face

in thinking about how to close the funding gap

Our incom

eO

il income

Perm

anent Fund earningsO

ther currentrevenuesN

ew tax revenues

-What w

e add to our savings

Royalty deposits to the P

F principalInflation proofing deposits to the P

F principalW

hat we add to the P

F earnings reserveW

hat we add to the C

BR

F+ W

hat we

take out of our savings

What w

e take out of the PF earnings reserve

What w

e take out of the CB

RF

= What w

e can spend

Governm

entspendingD

ividend spending

Any choice that we m

ake about anything affecting our revenues, spending or w

hat we add to or take out of our

savings affects our options for all our other choices.

1. What should w

e assume about

oil prices, oil production, and Permanent Fund rates of return?

35

Oil prices &

oil production affect our

oil income.

Our incom

eO

il income

Perm

anent Fund earningsO

ther currentrevenuesN

ew tax revenues

-What w




F principalW

hat we add to the P

F earnings reserveW

hat we add to the C

BR

F+ W

hat we

take out of our savings

What w


What w


RF

= What w

e can spend

Governm

entspendingD

ividend spending

Perm

anent Fund rates of return affect our P

ermanent Fund

earnings.

2. How

much do w

e want to tax ourselves or our industries?

Our

income

Oil incom

e

Perm

anent Fund earnings

Other current revenues

New

tax revenues

-What w




F principalW

hat we add to the P

F earnings reserveW

hat we add to the C

BR

F

+ What w


What w


What w


RF

= Our

spendingG

overnmentspending

Dividend spending

36

The more w

e raise from

new taxes the m

ore we

can spend.

3. How

much do w

e wish to add to or take out of our savings?

Our

income

Oil incom

e

Perm

anent Fund earnings


New

tax revenues

-What w




F principalW

hat we add to the P

F earnings reserveW

hat we add to the C

BR

F

+ What w


What w


What w


RF

= Our

spendingG

overnmentspending

Dividend spending

37

How

much w

e add to or take out of our savings affects w

hat how m

uch w

e can earn and spend in the future.

The less we spend now

, the m

ore we can spend

in the future—

and vice versa.

4. How

much do w

e want to spend on governm

ent and dividends?

Our

income

Oil incom

e

Perm

anent Fund earnings


New

tax revenues

-What w




F principalW

hat we add to the P

F earnings reserveW

hat we add to the C

BR

F

+ What w


What w


What w


RF

= Our

spendingG

overnmentspending

Dividend spending

38

The more w

e spend for dividends, the less w

e can spend for governm

ent—

and vice versa.

Our options and choices for w

hat we can spend

are fundamentally constrained by

our future oil revenues and permanent fund earnings.

They are also uncertain because we don’t know

what

oil prices and permanent fund rates of return.

The following graphs illustrate w

hat the rangeof w

hat we could spend m

ight befor different com

binations of assumptions.

39

What our current oil and other revenues w

ould be at different oil prices

What the Perm

anent Fund would earn at different rates of return

These projections assume that all earnings of the Perm

anent Fund are spent except those neededto allow

the fund to grow at the rate of inflation, so that its real value stays the sam

e.

How

much can w

e spend per year for government and dividends com

bined?

from our current revenue sources (oil revenues, non-oil revenues, and PF investm

ent earnings)w

ithout reducing the inflation adjusted value of the Permanent Fund over the next 10 years?

5%6%

7%8%

9%$40

2,9003,450

4,0004,600

5,150$50

3,2003,750

4,3004,900

5,450$60

3,6004,200

4,7505,300

5,900$70

3,9004,450

5,0505,600

6,200$80

4,2504,800

5,3505,950

6,500D

OR

forecast3,950

4,5005,100

5,6506,200

Average Permanent Fund R

ate of Return

Price of oil It depends on the price of oiland the Perm

anent Fund rate of return.

If we raise new

revenues we could spend m

ore.

If we w

ant the Permanent Fund to grow

we have to raise new

revenues or spend less.

How

much can w

e spend per year for government?

from our current revenue sources (oil revenues, non-oil revenues, and PF investm

ent earnings)w

ithout reducing the inflation adjusted value of the Permanent Fund over the next 10 years?

It depends on the price of oiland the Permanent Fund rate of return

and on what w

e spend for dividends.

If we keep dividend spending at last year’s total ($1.4B) w

e could spend:

5%6%

7%8%

9%$40

1,5002,050

2,6003,200

3,750$50

1,8002,350

2,9003,500

4,050$60

2,2002,800

3,3503,900

4,500$70

2,5003,050

3,6504,200

4,800$80

2,8503,400

3,9504,550

5,100D

OR

forecast2,550

3,1003,700

4,2504,800

Price of oil

Average Permanent Fund R

ate of Return

If we raise new

revenues we could spend m

ore.If w

e spent less for dividends we could spend m

ore.

Our fiscal options aren’t so bad com

pared with m

ost other states.

•M

ost other states:–

Don’t have any

oil revenues–

Don’t have any

Permanent Fund earnings

•That’s w

hy most other states:

–Spend m

uch less for government

–H

ave income taxes and/or sales taxes

–D

on’t pay dividends

•O

ur basic fiscal options are to become m

ore like other states:–

Spend less for government

–Tax ourselves m

ore–

Pay smaller dividends

44

Two potential approaches to using Perm

anent Fund earningsto fund state governm

ent

Approach

History/background

Senate B

ill 114Introduced

during the 2015 legislative session

Walker adm

inistration’s “sovereignw

ealth fund” proposal

Proposal released by W

alker adm

inistration Fall 2015

45

Major Alaska state revenues and spending flow

s, FY16

GeneralFund O

ilroyalties

Governm

entspending

Perm

anent Fundrealized earnings

Constitutional

Budget

ReserveFund

Perm

anentFund

principal

Perm

anentFund

earningsreserve

Non-O

ilR

evenuesO

iltaxes

Dividend

spending

Arrow sizes are

proportionalto FY16

revenue & spending flow

s

SB 114 approach: “Swap” funding for dividends and governm

ent

GeneralFund O

ilroyalties

Governm

entspending

Perm


Constitutional

Budget

ReserveFund

Perm

anentFund

principal

Perm

anentFund

earningsreserve

Non-O

ilR

evenuesO

iltaxes

Dividend

spendingD

ividends would be paid

from 75%

of oil royalties

A payout would go from

P

ermanent Fund earnings to

the General Fund based on

5% of average m

arket value over the past 5 years.

Sovereign wealth fund approach: Alm

ost all oil revenues would go to the

Permanent Fund, w

hich would m

ake a fixed payout to the General Fund.

GeneralFund O

ilroyalties

Governm

entspending

Perm


Constitutional

Budget

ReserveFund

Perm

anentFund

Non-O

ilR

evenuesO

iltaxes

Dividend

spendingD

ividends would be paid

from 50%

of oil royalties

A fixed annual payout would

go from the P

ermanent Fund

earnings reserve to the G

eneral Fund(estim

ated @ $3.2 B

)

160108 gunnar knapp-an introduction to alaska fiscal facts and choices-january 8, 2015 02(1)(1)

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