1. 1
An Introduction to
Alaska Fiscal Facts and Choices
Gunnar Knapp
Director and Professor of Economics
Institute of Social and Economic Research
University of Alaska Anchorage
Gunnar.Knapp@uaa.alaska.edu
January 7, 2016
ISER publications and presentations are solely the work of individual authors and should be
attributed to them, not to ISER, the University of Alaska Anchorage, or the research sponsors.
2. Alaska faces an extremely serious fiscal challenge.
My goal in this presentation is to
help Alaskans understand the basic facts of
this state finances and the choices we face.
I am not advocating for any particular choices.
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3. Alaska’s faces an extremely serious fiscal challenge.
We are spending more than twice as much as our revenues.
We are paying for the deficit by drawing down our savings.
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4. We can’t continue to run huge deficits like this year’s.
We don’t have enough savings.
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5. In the next few years,
we will have to close the funding gap
between our spending and our revenues.
We will have to make big changes
in what we spend or how we pay for it—or both.
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6. Outline
• Alaska fiscal facts
– State revenues
– State spending
– The Permanent Fund
• Alaska fiscal choices
– How to close the funding gap?
– When to close the funding gap?
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8. What most states’ revenues and spending flows look like
General
Fund
Unrestricted
General Fund
spending
Savings
Fund
Non-Oil
Revenues
Federal
revenues
Spending
for federally
mandated
uses
Designated
General Fund
revenues
Spending for
designated
uses of
revenue
sources
9. Major Alaska state revenues and spending flows, FY16
General
Fund
Oil
royalties
Government
spending
Permanent Fund
realized earnings
Constitutional
Budget
Reserve
Fund
Permanent
Fund
principal
Permanent
Fund
earnings
reserve
Non-Oil
Revenues
Oil
taxes
Dividend
spending
Arrow sizes are
proportional
to FY16
revenue &
spending flows
10. From 2005 to
2014, oil
revenues
averaged 90% of
Alaska’s
“unrestricted
general fund
revenues”
(which pay for
state
government).
Alaska has been extremely dependent on
oil revenues to fund state government.
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11. 11
Our state revenues are extremely sensitive to oil prices
—particularly at prices above $80/barrel.
12. Oil prices have fallen drastically over the past year and a half
—and are continuing to fall.
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The price was
$36/barrel on
December 11
13. ProjectedHistorical
$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.
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From 2005
to 2012 oil
prices and
revenues
rose
dramatically
14. In just four years,
most of the money we had been
using to pay for state government
evaporated.
It’s gone.
That’s why we have a big problem.
15. Won’t oil prices go back up and save us?
• It happened before—in the early 2000s—when we faced a similar fiscal
challenge.
• It could happen again. But it probably won’t.
– There is a glut of oil on world markets
– Most oil market analysts think prices won’t rebound above $70-
$90/barrel, because
• So much oil production is profitable at those prices
• Growth in world oil demand is slowing
• Even if oil prices rise, our revenues will fall as oil production falls.
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Hoping that oil prices rise is not a realistic
or responsible solution to our fiscal challenge.
16. At $70-$90/barrel, how much total revenue would we get?
$3.3 billion @ $90/barrel
$2.2 billion @ $70/barrel
We are spending
$5.2 billion this year.
17. Even if oil prices rise, our oil revenues will decline as production falls.
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18. From 2005 to 2012, even though spending was rising,
we ran big General Fund surpluses. Since 2013 we
have been running big General Fund deficits.
ProjectedHistorical
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19. We used the surpluses prior to 2012 to build up our savings reserve.
Since 2013 we have been rapidly drawing down our reserves.
Continued deficits of this year’s level could drain our reserves in 2 years.
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ProjectedHistorical
20. 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
$7,100
per Alaskan
$4,900
per Alaskan
$2,200
per Alaskan “Per Alaskan”
figures are based
on 2014 Alaska
population estimate
of 735,601.
21. How we are spending $5.2 billion in FY16
1,247 (96%) is
K-12 formula
641 (55%) is
Medicaid formula
23. The most unusual, complicated and least understood part of state finances
is the Permanent Fund and the Dividend Program.
General
Fund
Oil
royalties
Government
spending
Permanent Fund
realized earnings
Constitutional
Budget
Reserve
Fund
Permanent
Fund
principal
Permanent
Fund
earnings
reserve
Non-Oil
Revenues
Oil
taxes
Dividend
spending
24. Constitutionally mandated
contributions from
oil royalties to
Permanent Fund principal
about 30.5% of oil royalties
about $0.9 B in FY16
Inflation
proofing
about $0.9 B
in FY16
Permanent
Fund
Principal
$47.3 B
May not
be spent
Permanent Fund realized earnings
about $2.7 B in FY16
Permanent
Fund
earnings
Reserve
$7.6 B
May be
spent
Dividend spending
about $1.4 B in FY16
Formula: about half of realized
earnings over the past 5 years
25. The Permanent Fund is worth more than $50 billion. We can only
spend the “realized earnings” in the earnings reserve, which are
currently about $7 billion.
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26. The Permanent Fund has been earning billions of dollars in most recent years.
We have been putting that money in the earnings reserve—and then drawing
money back out to pay for dividends and inflation proofing.
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27. We have been using Permanent Fund earnings to pay for
dividends and inflation proofing.
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28. In most recent years the Permanent Fund has earned more than we have used
for dividends and inflation proofing—so we have been retaining some earnings
and the earnings reserve has been growing.
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29. Like oil revenues, Permanent Fund earnings are highly variable—but they
have been growing as the Fund grows. For the past two years they have
been more than our oil revenues.
ProjectedHistorical
31. HOW WILL WE FILL THE FUNDING GAP?
Our only significant and practical options are some combination of:
Spending cuts
New revenues
Using Permanent Fund earnings
by some combination of:
- Reducing Permanent Fund dividends
- Reducing inflation proofing
- Adding less to the Earnings Reserve
- Drawing down the Earnings Reserve
There are no easy choices.
The funding gap is so large that
we may need to use all of these options.
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32. The challenge with spending cuts is figuring out what to cut that isn’t
mandated, essential or “penny-wise but pound-foolish.”
Very little
capital
spending is
left to cut
It would be
very difficult to
cut debt &
retirement
spending
Cutting oil tax
credits could
affect future
production
and revenues
Most cuts would have to come from state
agencies—including education & health
33. There are many potential options for new state revenues
—but none would be enough to close the funding gap.
34. Alaskans pay much lower broad-based state taxes
than residents of any other state.
Alaska 34
35. Using Permanent Fund earnings would require some combination of:
- Reducing Permanent Fund dividends
- Reducing inflation proofing
- Adding less to the Earnings Reserve
- Drawing down the Earnings Reserve
36. The Permanent Fund can earn us billions of dollars each year.
But the earnings will vary widely depending on the rate of return we earn
and how large we grow the fund.
Rates of return
1996 – 2015
(omits -6.8% return in 2009)
Estimated
start-of-FY17
value
APFC projections
for start-of-FY26
value with status
quo management
APFC projections
assume average 4.88%
statutory return
37. Three potential approaches to using Permanent Fund earnings
to fund state government
Approach History/background
Legislature appropriates funds from the
earnings reserve, with or without changes in
dividends and inflation proofing
The legislature can do this by a
simple majority vote
Senate Bill 114 Introduced during the 2015
legislative session
Walker administration’s “sovereign wealth
fund” proposal
Proposal released by Walker
administration Fall 2015
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38. SB 114 approach: “Swap” funding for dividends and government
General
Fund
Oil
royalties
Government
spending
Permanent Fund
realized earnings
Constitutional
Budget
Reserve
Fund
Permanent
Fund
principal
Permanent
Fund
earnings
reserve
Non-Oil
Revenues
Oil
taxes
Dividend
spending
Dividends would be paid
from 75% of oil royalties
A payout would go from
Permanent Fund earnings to
the General Fund based on
5% of average market value
over the past 5 years.
39. Sovereign wealth fund approach: Almost all oil revenues would go to the
Permanent Fund, which would make a fixed payout to the General Fund.
General
Fund
Oil
royalties
Government
spending
Permanent Fund
realized earnings
Constitutional
Budget
Reserve
Fund
Permanent
Fund
Non-Oil
Revenues
Oil
taxes
Dividend
spending
Dividends would be paid
from 50% of oil royalties
A fixed annual payout would
go from the Permanent Fund
earnings reserve to the
General Fund
(estimated @ $3.2 B)
40. How would different options for closing the fiscal gap affect
Alaska’s economy and Alaskans?
Option Effect on the economy Who would be most affected
Cutting spending Fewer government jobs & income
Fewer contractor jobs & income
Multiplier effects of lower spending by
government & contractor employees
Government employees
Contractor employees
Trade and service industry businesses &
employees
Beneficiaries of government services that are cut
Income taxes
Sales taxes
Less personal income
Multiplier effects of lower spending by
households
Wealthier families (income taxes)
All families (sales taxes)
Trade and service industry businesses &
employees
Resource industry taxes Less business income
Fewer resource industry jobs
Multiplier effects of lower spending by
resource industry businesses & households
Resource industry businesses & families
Trade and service industry businesses &
employees
Cutting dividends Less personal income
Multiplier effects of lower spending by
households
All families (relative effects greatest for poor
families & large families)
Trade and service industry businesses &
employees
Cutting inflation proofing
Adding less to or drawing
down the earnings
reserve
No immediate effect
Slower Permanent Fund growth
Lower future Permanent Fund earnings
Future Alaskans
41. WHEN WILL WE FILL THE FUNDING GAP?
The more gradually we adjust,
the smaller the immediate 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 confidence
The greater the risk to our credit rating
The lower our future investment earnings
The less savings we leave for future generations
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43. Our fiscal options aren’t so bad compared with most other states.
• Most other states:
– Don’t have any oil revenues
– Don’t have any Permanent Fund earnings
• That’s why most other states:
– Spend much less for government
– Have income taxes and/or sales taxes
– Don’t pay dividends
• Our basic fiscal options are to become more like other states:
– Spend less for government
– Tax ourselves more
– Pay smaller dividends
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