Legislature(2015 - 2016)FAHRENKAMP 203
03/15/2016 09:00 AM Senate STATE AFFAIRS
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SB 128-PERMENANT FUND: DEPOSITS; DIVIDEND; EARNINGS 9:35:22 AM CHAIR STOLTZE announced the consideration of SB 128. 9:35:55 AM RANDY HOFFBECK, Commissioner, Alaska Department of Revenue, Juneau, Alaska, thanked the committee and Senator McGuire for their efforts in putting forward a plan that would create a stable and durable fiscal plan for the State of Alaska. He opined that Alaskans were concerned about government's level of spending during high revenues and the importance of having spending accountability so that the state is dealing with a boom-and-bust economy. 9:38:09 AM He asserted that the Alaska Permanent Fund Protection Act (APFPA) encapsulates the volatility within the Permanent Fund by putting the oil and gas tax with the royalty revenues into the Permanent Fund. He added that a secondary advantage was created where the lows within the system were taken out as well. He stated that the current low-oil price environment necessitated stress testing the plan's revenue models with extreme scenarios in order to make sure goals were accomplished even in times that rarely occur. He revealed that the plan's modeling did survive the highs and lows of a commodity-based economy. He added that after a series of tests with thousands of iterations, the plan could sustainably draw $3.3 billion from combining oil and gas revenues with investment returns on a sustained basis. He reported that the private sector had expressed the need for government to stabilize its portion of the state's economic base. He conceded that after attempts to diversify the state's economy over the years, Alaska has two primary economic engines: resource development, the commodity side; and government spending, both state and federal. He remarked that there was very little that could be done on the commodity side of the equation, but the one thing that could be stabilized was government spending. He added that the private sector clearly stated their need for stability in order to make long-term financial decisions and investments. He said the lows were taken out to address the private sector's difficulty in making long term commitments due to uncertainty. 9:40:45 AM CHAIR STOLTZE asked how Commissioner Hoffbeck has responded to businesses that either support a smaller government or the sector dependent on government activity. COMMISSIONER HOFFBECK answered that both discussions have occurred. He detailed that discussions have primarily been on government's size, followed by predictability and stability. He summarized that people want to pay for the right size of government, not excessive government. CHAIR STOLTZE commented that predictability and stability were the most important parts and both were being impacted for the largest revenue producers. 9:42:32 AM COMMISSIONER HOFFBECK answered correct. He set forth that the APFPA was a good plan that worked by taking the volatility component out of the system. He asserted that thinking had to be different, dynamic, and immediate action was needed. He said the administration can suggest, but the Legislature had to make the choices. He asserted that big problems don't get easier by waiting. He remarked that closing the $3.5 billion to $4 billion deficit in a year and a half, two legislative sessions, would be something that nobody really believed could be accomplished. He opined that even after the deficit was closed, the individual tax burden for Alaskans would still be one of the lowest in the nation. He detailed that the dividend would be protected, a dividend that no other state pays; the state's savings would continue to grow at least at the rate of inflation, if not greater; children's and grandchildren's future would be protected; most of the government's services that Alaskans have enjoyed over the years would be preserved; and money would be left to invest in the state's resources. 9:46:31 AM SENATOR HUGGINS asked that Commissioner Hoffbeck summarize the five traits that he was looking for. COMMISSIONER HOFFBECK summarized as follows: 1. Keep the individual tax burden as low as possible. 2. Preserve the dividend. 3. Preserve the Permanent Fund's corpus for future generations. 4. Retain as many essential government services as possible. 5. Have money available to support resource development. 9:47:52 AM CRAIG W. RICHARDS, Attorney General, Alaska Department of Law, Juneau, Alaska, set forth that the governor's plan does three things as follows: 1. Places the volatile petroleum revenues, production tax and royalties directly into the Permanent Fund. Revenues from oil and gas are no longer large enough to sustain government. 2. Annually draws $3.3 billion out of the Permanent Fund to the General Fund. All of the cash-flow streams would act as an annuity. Revenues from oil and gas are no longer large enough to sustain government. 3. Changes the dividend formulation from one based on a five- year average of half of the Permanent Fund earnings to a royalty formulation of half of royalties. 9:50:40 AM CHAIR STOLTZE noted that Senator McGuire's plan was not to fill the whole gap with Permanent Fund earnings, but to provide a substantial gap. He opined that the governor's "annuity" approach may make the state dependent on just the payout. ATTORNEY GENERAL RICHARDS replied that neither Senator McGuire's POMV approach under SB 114 nor the governor's plan could take enough out of the Permanent Fund to fully fund state government's $4 billion budget. CHAIR STOLTZE asked Attorney General Richards to verify that Attorney General Richards did not want to be misinterpreted that people could not be taxed enough. ATTORNEY GENERAL RICHARDS clarified that Chair Stoltze's question was whether or not the administration was leaving to the Legislature the flexibility to budget how they want. He specified that the answer between SB 114 and the governor's plan was SB 114 annuitizes one type of wealth and the governor's plan annuitizes two types of wealth. ATTORNEY GENERAL RICHARDS detailed that SB 114 takes a measure of the Permanent Fund's value, not its earnings, the actual cash flow, and takes the measured value and turns it into an annuity where "x" amount is taken out, but leaves the petroleum revenues' volatility in the General Fund. He added that the third component was the gap that was not covered by the petroleum revenues and the Permanent Fund. He asserted that no one's plan was going to be able to close the gap because the petroleum revenues and the Permanent Fund were not big enough. He asserted that SB 114 annuities the Permanent Fund's earnings. He pointed out that the administration's plan does both the Permanent Fund's earnings and the petroleum revenues to provide more stability than just annuitizing the Permanent Fund earnings themselves. He reiterated that both plans only get part of the way there, which leaves the Legislature to decide whether to cut more or increase revenues. 9:54:09 AM He revealed that the state's unrestricted budget compared with unrestricted petroleum revenues have tracked each other very closely. He explained that the government spends a lot more money when it has a lot of money from petroleum revenues, and the government has to find a way to spend less when it has less. He pointed out that the Legislature has been incredibly disciplined in terms of saving Permanent Fund earnings. He specified that the state has had a rules-based system in place around the Permanent Fund for over 30 years. He detailed that the rules-based system inflation proofs the Permanent Fund corpus, pays out a dividend and then customarily, not a legislative requirement, of not appropriating the Permanent Fund earnings reserve or otherwise taking money out of the system. Even though there has not been particularly a large amount of discipline in saving monies in high oil environments, there has been an incredible amount of discipline in terms of how the Legislature approaches the Permanent Fund. He set forth that the Legislature has shown a willingness, ability and desire to follow a structured rule-based framework versus the tendency to spend the money that is available. He summarized that one of the goals was not only reducing volatility, but to put around the petroleum revenues some rule- based frameworks that would increase the likelihood of saving money and spending it on a plan rather than just year-to-year ad hoc. ATTORNEY GENERAL RICHARDS explained that the goal of the APFPA was to take the state off of the commodities rollercoaster in terms of governmental spending. He detailed that stable spending patterns makes state budgeting easier. He pointed out that Alaska's revenues have historically gone up and down over 50 percent. He noted that revenues where almost $10 billion in 2008 during the oil tax period from Alaska's Clear and Equitable Share (ACES) to this year's $2 billion. He summarized that going to a more annuitized system would make governmental budgeting easier and its consequence would roll through the state's economy as well. 9:57:51 AM He revealed that the International Monetary Fund (IMF) reported that natural-resource based economies tend not to do well because they do not have broad-based taxation and are subject to oil revenue's cyclicality. He said the IMF report suggests that finding a way to create a fiscal structure that was not reliant on year-to-year volatility would not only make governmental budgeting easier, but would actually improve an economy as a whole by avoiding the danger of "pro-cyclical spending" which was spending a lot when a government was flush with revenue. He pointed out that an economic double-whammy occurs when governmental spending was dramatically reduced at the same time that other economic sectors and petroleum development comes down. He noted that the IMF report concluded that diversifying oil based and commodity-based economies could mean as much as a 0.3 percent increase in annual GDP growth. He summarized that Alaska's economy was not broad enough to tax at a level that would diversify the state away from the oil and gas sector. He said the state has to find a way to use its sovereign wealth to develop a sound fiscal policy. 10:02:00 AM CHAIR STOLTZE addressed one of the rules Attorney General Richards talked about and said there's not a strict adherence. He specified that the constitution required 25 percent royalties for quite a while. He noted that the Legislature and the administration supported 50 percent and the percentage was reduced during the 23rd Legislature. He said some rules are more flexible than others. ATTORNEY GENERAL RICHARDS answered correct. He noted that he refers to what Chair Stoltze addressed as the Savings Rule and the Spending Rule. He specified that the Savings Rule has had variability in it, but he thought of past actions as doing a little extra. He said the Legislature has been incredibly disciplined regarding the Spending Rule where the rules framework has not been broken where the Earnings Reserve was raided for capital projects. SENATOR HUGGINS asserted that the State of Alaska pays for everything. He specified that his statement was an overstatement, but not far from the truth. He opined that the concept where the state pays for everything has not been addressed. ATTORNEY GENERAL RICHARDS reiterated that any solution with the Permanent Fund was a half-solution where a billion dollar differential would still exist. He opined that there was going to be lots of room for policy discussions on revenues and spending. 10:04:04 AM He set forth that a rules-based framework would sustain the Permanent Fund by: · Preserving the purchasing power or inflation proofing the value of the Permanent Fund over time to ensure that the next generation had the same level of wealth as the current generation. · Making sure the plan's durability modeling ensured enough money for annual draws to the General Fund and dividends. · Making sure the Earnings Reserve did not grow too large over time to decrease the chance of a raid. He added that a good policy would be taking what was not needed in the Earnings Reserve and moving it to the corpus. CHAIR STOLTZE noted that Attorney General Richards characterized any appropriation from the Earnings Reserve as a "raid." ATTORNEY GENERAL RICHARDS replied that he should frame the characterization as "ad hoc spending," spending from the Permanent Fund in a manner that was not under a sustainable plan. 10:06:22 AM He addressed the difference between the sovereign wealth fund model and a classical endowment model. He specified that the sovereign wealth fund model would house the petroleum revenues in the Permanent Fund itself. Under the classic endowment model, the petrol revenues would remain in the General Fund. ATTORNEY GENERAL RICHARDS said the next option was to decide whether to go with a fixed draw or a POMV draw. He explained that the governor's bill has several advantages where petroleum revenue volatility would be housed in the Permanent Fund with a fixed-draw amount. He specified that a fixed draw would allow for a smoothed out or averaged spending where a bit more spending would be possible in lower years and a bit more savings in higher years of petroleum revenues. He pointed out that the Permanent Fund and the POMV both use averages as a way to get reasoned calculations that do not jump all over the place. He said putting the petroleum revenues into the Permanent Fund was a similar concept where revenues are assigned a value and a certain amount would be spent every year. He suggested that petroleum revenue be thought of as an asset and deciding what amount of the asset can be spent every year on a sustained basis. He added that the governor's plan was similar to Scott Goldsmith's approach. 10:08:36 AM SENATOR HUGGINS asked Attorney General Richard to confirm that under the endowment model, the assumption was that the Permanent Fund maintains its traditional role and it would not be leveraged for something else. ATTORNEY GENERAL RICHARDS answered that the Permanent Fund would be in its traditional role plus some kind of endowment-like payment to the General Fund plus dividends. SENATOR HUGGINS asked if the Permanent Fund would be destabilized or volatility created if the fund was used as a backstop for a gas pipeline. ATTORNEY GENERAL RICHARDS answered that he did not know, but suggested that there were several ways to do it. He remarked that he has not heard anyone propose using the Permanent Fund in the manner Senator Huggins suggested; but if used, he opined that the Permanent Fund would directly invest as opposed to backstopping bonds. He noted that the fixed amount and POMV were both reasonable and produce the same amount of money over time; however, the percentage of market value approach would have more fluctuation. He reiterated that the biggest difference between the governor's approach and SB 114's sovereign wealth was where oil price volatility would reside. He said the disadvantage of having oil price volatility reside in the General Fund was that the state would be stuck with the annual amount that could be collected. He specified that reasoned assumptions could not be made about how much could be spent over time, which meant there would always be volatility in the General Fund. 10:11:46 AM ATTORNEY GENERAL RICHARDS explained that a hypothetical modeling exercise was done by the Department of Revenue to show what would have happened if the POMV concept was enacted in the past. He pointed out that the modeling showed that the POMV approach would not have smoothed out the volatility-curve associated with oil prices and additional layers would have been laid on the volatility. He said the layering would have made sense in the low years because the revenues would have been needed to meet budgeting needs, but in high years an unadjusted POMV would have compounded pro-cyclical spending because savings would be placed into a general fund that already had excess revenues. He remarked that the revenue-limitation amendment that the committee passed was a good amendment because during high oil price environments, money from savings would not be put into a budget that was already highly funded. He explained that the difference between the revenue limit and what the governor's bill does was as follows: 1. Does not provide for automatic savings of the petroleum revenues at very high revenues. 2. Does not allow for spending a constant level of petroleum revenues over time regardless of what is collected. 3. Volatility in the General Fund would continue to exist under the revenue-limit cap. CHAIR STOLTZE clarified that not spending would increase the likelihood of spending. ATTORNEY GENERAL RICHARDS answered correct. He specified that the POMV payout does not provide a limitation on spending or revenues in terms of excess oil revenues. He remarked that the revenue limitation would do a very good job of making sure that financial savings were not spent when it's not needed, but the amendment would not go to the next step of ensuring financial savings at real high oil prices. 10:14:29 AM ATTORNEY GENERAL RICHARDS addressed the different dividend methodologies and noted that two combinations did not make the most sense mathematically. He said using a POMV draw with an earnings-based dividend was a little dangerous because the POMV was a pretty steady amount, but the earnings-based dividend would always be very variable and the result would make it harder to depend on revenues to the General Fund each year. He said the preferred alternative to a POMV draw and an earnings- based dividend would be to base the dividend on the market value of the fund rather than year-to-year earnings, the end result would not have the variability and swings that exist under the current system. He remarked that although variability and swings might be good policy in terms of people's dividends, variability rather than stability in revenue to the General Fund did not make sense. He said the other type of dividend combination that he found mathematically challenging was SB 114's initial version with a royalty-based dividend and a PFD floor. He detailed that dividends would be paid out on the upside of oil prices, but guaranteed with a floor on the downside of oil prices. He asserted that the dividend plan under SB 114 would easily become unsustainable very fast. 10:17:44 AM SENATOR MCGUIRE thanked Commissioner Hoffbeck and Attorney General Richards for working with her office. She opined that an amalgamation of bills would ultimately happen because people understand where the state was financially. She analogized that people were at the acceptance level that a "root canal" must be performed. 10:19:57 AM SENATOR COGHILL commented that the real question was whether the state's wealth could be used to stabilize the government as the Legislature starts slimming down the budget. He said to date, the Permanent Fund earnings have not been used for general government purposes. He detailed that using the current methodology and taking money out of Permanent Fund earnings for government spending would highly impact the dividend. He stated that the intent in the governor's plan and SB 114 was to protect and sustain the value of the state's wealth when used for the first time in government services and the dividend. He said he appreciated the approach being taken and noted that that was the reason for his methodology change in introducing his amendment. He remarked that if the Legislature does not do anything, the Permanent Fund earnings could be used, but the impact on the dividend would be great and the state's volatility would not change. [CHAIR STOLTZE set SB 128 aside for further consideration.] SB 128-PERM. FUND: DEPOSITS; DIVIDEND; EARNINGS 2:36:48 PM CHAIR STOLTZE returned attention to SB 128. Finding no amendments or additional discussion, he solicited a motion. 2:37:01 PM SENATOR COGHILL moved to report SB 128 from committee with individual recommendations and attached fiscal notes. 2:37:07 PM CHAIR STOLTZE announced that without objection, SB 128 moved from committee.