Alaska Budget Cutting: Its Not Rocket Science …

The FY 2013 Enacted Budget (click on to enlarge)

As this page has discussed on other occassions, Alaska state government spending has rocketed out of control over the last six years. Fueled by increased revenues resulting from the passage in 2007 of substantial revisions to the oil tax structure (called “Alaska’s Clear and Equitable Share” or “ACES”), state General Fund spending has grown from an average of $2.5 billion in the years before the passage of ACES, to $4.5 billion in the four years following, to now, most recently, $6.72 billion for FY 2012 and $7.6 billion for FY 2013.

With those increases, state spending far exceeds sustainable levels. The University of Alaska Anchorage’s Institute of Social and Economic Research (“ISER”) most recently has estimated the state can sustain General Fund spending in the range of $5.6 billion indefinitely (this is up slightly from $5.3 billion estimated the year before). Spending above that level — as has occurred the last two years — comes out of the pocket of future Alaskans. As ISER puts it, at increased spending levels “[t]he fiscal burden [on future Alaskans] will grow every year ….”

As importantly, the increased spending levels also have put in jeopardy something else that is critical to Alaska’s future — reversing the decline in oil production. Based on testimony by the Director of the state Office of Management and Budget at the end of this spring’s Special Session, enacting the Governor’s proposed tax reform would send the state budget into an immediate deficit. The reason is not because the proposed tax reductions are too generous. Instead, the reason is that spending levels have risen so high that there is no longer room to accommodate the reduced revenue levels tax reform would require.

No legislature is likely to enact oil reform when the consequence is immediately to throw the state budget into deficit. As a result, from a practical perspective the current spending levels essentially have foreclosed pursuing oil reform until the spending levels are brought down significantly. That is of serious concern if you believe that reductions in the level of government take are a necessary component of reversing the ongoing decline in Alaska oil production.

Interestingly, however, bringing the budget back within sustainable levels — and creating room to address oil reform — is not particularly difficult. While it will take significant political will, the path forward is fairly clear.

A Sidebar: Why Alaska Needs to Save Now …

There are two major components to Alaska’s overall spending levels — the Operating Budget and the Capital Budget. The largest portion of the revenue for each comes from the General Fund. The other sources of revenue received by the state, particularly including federal funds, come with various restrictions and are not easily controlled. Spending from the General Fund, however, is largely discretionary.

For FY 2013, General Fund spending within the Operating Budget is budgeted at $5.6 billion. General Fund spending within the Capital Budget is $1.9 billion.  The combined spending level is $7.6 billion (taking into account rounding), compared with ISER’s sustainable budget level of $5.6 billion, a difference of $2 billion.

Despite at least one Senator’s recent claim to the contrary, the Capital Budget is the most out of control. The Capital Budget for the last two years has been $1.9 billion (FY 2013) and $1.6 billion (FY 2012). Prior to that the Capital Budgets were much, much lower. The average Capital Budget in the first four years subsequent to ACES averaged less than half a billion dollars ($.43 billion, to be precise). The last Capital Budget before the passage of ACES was only $.34 billion.

Not only have the last two Capital Budgets been out of alignment with history, they also vastly exceeded the Governor’s recommendations. The Governor’s initial proposed Capital Budget for FY 2013 was $.88 billion, later amended slightly to $.89 billion. The proposed Capital Budget for FY 2012 was $.64 billion, later increased to $.71 billion.

As a consequence, an easy first step in reigning in the budget to sustainable levels is to reduce the Capital Budget to something which better reflects historic practice. Reducing the overall FY 2013 Capital Budget to the level maintained in the first four years following the passage of ACES would save $1.5 billion. Reducing it to the average Capital Budget proposed by the Governor over the last two years would save $1.1 billion. Reducing it simply to the Governor’s proposed level for FY 2013 still would save slightly over $1 billion.

Of course, the more savings that can be achieved from reductions in the Capital Budget, the fewer reductions that are required in the Operating Budget. If the Capital Budget is returned to the average level spent in the four years following the passage of ACES, the Operating Budget will only need to be cut by $500 million to achieve the overall level of savings necessary to reach sustainable levels. If the Capital Budget is reduced only to the level proposed by Governor Parnell for FY 2013, however, the level of reductions in the Operating Budget will need to be roughly twice that, or $1 billion.

There are two places in the Operating Budget that should be looked to for near term reductions.

The first is the $400 million allocated to “Oil and Gas Tax Credits” (click on the FY 2013 Budget at the top of this commentary to follow along, Line 25). Those credits arise largely from ACES and are being paid to oil companies drilling in areas and in ways which the Legislature has decided require special incentives, because investors otherwise have not pursued them on their own. It is a classic case of politicians — rather than business — picking economic winners and losers.

The revenues used to fund the credits have been created by increasing tax rates for production from within existing units. The result is that the Legislature has disincentivized expanded development in new areas within existing units — where there are known oil reserves — in order to incentivize exploration in new areas outside of existing units — where there is little to suggest significant oil is located. For a more detailed discussion of this issue, see “Alaska Oil Tax Policy: Ships Passing in the Night” (Alaska Business Monthly, July 2012).

These credits should be substantially reduced, if not eliminated, in the course of oil reform. Business decisions — picking economic winners and losers — should be returned to the hands of investors.

The second area in the Operating Budget that should be looked to for near term reductions is the $2.1 billion allocated to “Agency Operations (Non-formula)” (Line 8). A “formula” program is one “with specific eligibility standards which guarantees a specific level of benefits for any recipient who qualifies. The eligibility standards and benefits must be based in statute.”

The $.8 billion allocated to “formula” programs (Line 14) is difficult to reduce in the near term because it would require changing the relevant eligibility standards. The $2.1 billion allocated to non-formula programs is not subject to the same limitation.

A small portion of the $2.1 billion appears to be “matched” to federal funds. “Matched” funds are “[s]tate monies that must be appropriated in order for the state to receive federal or other non-state receipts for a specific program or capital project.” Reductions in those funds would result in corresponding reductions in federal or other funds and thus, need to be examined closely. A large part of the $2.1 billion, however, are in unmatched funds.

Assuming the Capital Budget is reduced to historic levels — resulting in a reduction of $1.5 billion from FY 2013 levels — finding the $500 million in additional spending reductions necessary to achieve an overall sustainable budget level of $5.6 billion should be relatively straightforward. Eliminating all or most of the “Oil & Gas Tax Credits” achieves most of the objective; identifying the remainder within the $2.1 billion budget for “Agency Operations” should be relatively simple.

The level of challenge increases, however, the smaller the reductions made in the Capital Budget. If the Senate, which manages the Capital Budget, insists on mainaining capital spending levels in the range of the $800 million proposed by the Governor over the last two years, for example, an additional $500 million in savings will need to be identified in the Operating Budget.

That will require significantly deeper cuts in the amounts allocated for Agency Operations (Non-formula), likely the elimination of the entire $60 million allocated to “Revenue Sharing” (Line 23) and at least some reduction (likely in the range of $250 million combined) in Education (Line 13) and Agency Operations (Formula).

Some in the legislature appear to believe that making these cuts is an inappropriate, if not impossible, task. For example, the so-called House “Special Committee on Fiscal Policy” says in its website, “Understanding Alaska’s Budget,” that “there is a limit to what can be done without gutting essential services that Alaskans rely on,” because Alaskans have become “used to receiving high levels of service from our government.”

As I have explained elsewhere, that conclusion condemns future Alaskans to a significantly reduced standard of living as compared with current residents, either as a result of necessary reductions in future “levels of service from our government” or as a result of the need to introduce income, sales and property taxes to continue to fund them.

That future should be unacceptable. As at the federal level, current generations should not be permitted to live above their means at the expense of requiring future generations to live at a reduced standard of living.  It doesn’t take rocket science to avoid it, just political will.