Alaska Fiscal Policy| Where We Have Gone Wrong

In March, the University of Alaska Anchorage’s highly respected Institute of Social and Economic Research (“ISER”) published a paper entitled “Managing Alaska’s Petroleum Nest Egg for Maximum Sustainable Yield” (.pdf). The paper is the continuation of an effort started last year (.pdf) by ISER’s Scott Goldsmith to determine the appropriate level of annual state government spending, if the objective is generally to maintain a consistent, inflation adjusted level of state spending over time.

The purpose of ISER’s effort is much the same as retirement planning for an individual. In retirement planning the goal is identify the maximum level of annual spending from an individual’s retirement account that will allow the generation of a relatively consistent stream of annual income for the rest of the retiree’s life. The ISER study is designed to determine the level of spending that is prudent in order to ensure that future Alaskans continue to receive the same level of government goods and services that are available to current Alaskans.

ISER’s terminology – “maximum sustainable yield” – is derived from the Alaska Constitution. Article VIII, Section 4 of the Alaska Constitution provides that “Fish, forests, wildlife, grasslands, and all other replenishable resources belonging to the State shall be utilized, developed, and maintained on the sustained yield principle, subject to preferences among beneficial uses.”

While not necessarily a legally compelled reading of the section, ISER’s premise is that the state’s financial resources and the income from its other significant revenue-producing assets – mostly oil – if invested and used wisely, are “replenishable resources” in the sense that they can produce a steady stream of revenue indefinitely. As such, fiscal and oil resources should be used in the same manner as the state’s other “replenishable” resources, which is to say current consumption should be moderated in order to provide a sustainable yield to future generations.

Like fish, if the current rate of “take” (i.e., state spending) is too high – higher than can be supported by the state’s asset base on a sustained basis – the state’s “nest egg” is eroded and the revenue available for spending in future years is reduced. In short, setting the rate of state spending at higher than sustainable levels will leave future generations of Alaskans worse off than the current generation.

After investing substantial time studying the foundation and computations behind their analysis, I have come to believe that ISER’s approach offers a compelling vision of how Alaskans should look at state spending. Setting state spending levels at or below the “sustainable level” calculated using ISER’s approach is defensible and prudent, and consistent with the approach underlying Article VIII, Section 4 of the Constitution.

Spending above those levels, on the other hand, should be viewed as an attack on the economic health of future Alaskans – which includes anyone who intends to continue living in the state of Alaska beyond a very short window. The ISER study states this proposition more directly – “[t]he fiscal burden [on future Alaskans] will grow every year and the nest egg will shrink at an accelerating pace, until the state reduces spending or finds an alternative source of revenue [to oil].”

Sadly, it appears that Alaska’s most recent generation of political leaders has failed to grasp this principle and is leading Alaska off the fiscal cliff.

Applying ISER’s approach and calculations, the maximum level of sustainable state spending from General Fund Petroleum Revenues for FY 2012 is $5.35 billion (“The state could spend $5.35 billion of [General Fund petroleum revenues] without compromising its future ability to provide the current level of public services.”) Taking into account the supplemental budget passed in the most recently concluded legislative session, however, actual General Fund spending for FY 2012 is currently projected to reach $6.8 billion, approximately $1.5 billion over the maximum level of sustainable state spending suggested by the ISER approach.

The news becomes worse, much worse for FY 2013. The recent operating and capital budgets passed by the Legislature, and signed earlier this week by the Governor, provide for combined General Fund spending of $7.6 billion. Because the maximum level of sustainable state spending does not vary significantly from year to year, approved spending levels for FY 2013 exceed sustainable levels by roughly $2.25 billion.

This does not take into account additional spending created by the $397 million in General Obligation bonds approved by the Legislature in 2010, and the $450 million in additional bonds approved by the Legislature this session and appearing on the ballot this coming fall. While the bonds technically do not count as current spending, the scheduled repayment of those obligations will burden future Alaskans just as much by reducing the amount of revenues available for spending on then-current needs.

This level of excessive spending was not always the case. Prior to FY 2008 – the first budget of the Palin/Parnell Administrations – state spending levels were relatively moderate. During FY 2004 – 2006, for example, General Fund spending was only (.pdf) $2.3 billion, $2.3 billion and $3.0 billion. From FY 2008 forward, however, state spending has exploded. The comparable numbers for FY 2008 – 2013 are as follows (.pdf): $4.25 billion, $5.0 billion, $4.23 billion, $5.1 billion, $6.72 billion and $7.6 billion. While any one year might be excused as an anomaly, the succession of six such years in a row – and the fact that the numbers are escalating – leads to serious concerns about where the state’s fiscal policy is headed.

In short, just six years after the fact, General Fund spending for this coming year alone (FY 2013) is budgeted to exceed the total amount spent in the three years from 2004 – 2006. Looked at another way, the amount of excessive spending – spending above sustainable levels – for FY 2013 alone will exceed the entire General Fund budget for each of FY 2004 and 2005.

Both the Legislature and Administration share responsibility for this situation. While the Legislature passed the budgets, the Palin/Parnell Administrations have been deeply involved at both the back and front ends of the process. At the front end, both Governors Palin and Parnell initially submitted proposed budgets which posited excessive spending levels from the outset, tacitly signaling to the Legislature that the levels were acceptable. At the back end, both Governors approved and signed each of the budgets; they did not exercise their line item veto power to bring the spending levels down to sustainable levels.

Most disturbing, however, is the apparent lack of understanding among state leaders of the broader consequences of their current approach to spending.

In a press release issued following the Governor’s signature earlier this week of the FY 2013 operating and capital budgets, Representative Bill Stoltze, Co-Chair of the House Finance Committee, said “[t]his is a responsible budget but not a sustainable budget. It is essential for Alaska that we increase production flowing through the Trans Alaska Pipeline with measures like reasonable and responsible oil tax reform.”

While it is helpful that Rep. Stoltze recognizes that the budget is not sustainable, it is disappointing that he apparently believes the reason it is not sustainable is because of lack of oil tax reform.

Actually, the reverse is the case – high spending levels have and are continuing to undermine the case for oil tax reform. In testimony before the House Resources Committee during the recent Special Session, Office of Management and Budget Director Karen Rehfeld said that, under the Governor’s proposed oil tax plan, “Alaska could be in deficit spending as early as next year,” with a budget shortfall “of $615 million next year and up to $1 billion by fiscal year 2018.” Even those levels may understate the extent of the problem. If as some have predicted, oil falls to $90/barrel or less in coming years, Alaska’s immediate budget deficits – even at current tax levels – will become significantly larger.

High spending levels undermine the case for oil tax reform because it is unlikely that any Legislature (last session’s or any in the future) will agree to oil tax reform if the consequence is immediately to put the budget into – or even approaching – a deficit.

Moreover, what the spending levels approved by the Legislature and Governor since the beginning of the Palin/Parnell Administrations have done is create special interests throughout the state which are vested in maintaining the current tax structure. For example, among a wide number of other things, the FY 2013 budget provides for state funding of artificial turf fields at both a middle school in Anchorage (Romig Middle School, $1.9 million) and a sports complex in Fairbanks (“synthetic turf fields for the Kiwanis Field and the adjacent Fairbanks Youth Soccer Association Field were funded at a grand total of $3.2 million”).

By creating widespread expectations for continued state spending on such things, the Legislature and Administration are seriously undermining what the Governor views as his Administration’s “Number 1 Priority,” oil tax reform. As long as Alaskans believe higher taxation leads to higher spending – and they aren’t the ones paying the higher taxes – they will continue, at least tacitly, to support maintaining the current tax structure in order to maintain spending.

The problems created by this spendthrift approach to fiscal policy, however, actually run much deeper than simply undermining the current prospects for oil tax reform.

Certainly, I recognize the safety aspects of astroturf, but elsewhere those type of needs universally are met either through private fundraising efforts or, if by government at all, locally. By allowing budget after budget to exceed sustainable levels, the state’s political leaders are undermining the ability of future Alaskans to maintain even a moderate level of fundamental state goods and services – roads, transportation, health.

In simple terms, the state is trading its long term fiscal health and stability for, among other things, astroturf. Such an approach sells out future Alaskans in order to benefit current Alaskans.

Another ISER study, “Revising the State Fiscal Plan to Account for Petroleum Wealth,” March 2011 (.pdf), makes this point succinctly. In that study, ISER examines the impact of current spending levels on the state’s statutory and constitutional budget reserves, and the ability of the state’s fiscal resources to maintain current state spending levels as oil production levels continue to soften. In case after case, the study finds that, at current spending levels, both the statutory and constitutional budget reserves are depleted within the next 15 years or so, and as a consequence, the state’s ability to maintain current state spending levels is exhausted.

It is ironic that a Legislature and Administration that claim to be “fiscal conservatives” have painted the state into this fiscal corner — but the fact is that is exactly what they have done in the last six years.  Going forward, reverting to truly “sustainable” spending levels is essential if Alaska is going to return to the right track.