What is Alaska’s “Fiscal Plan” …

Last week I heard one person ask another what their definition is of a “fiscal plan.” As more people begin to realize the state’s fiscal situation, I anticipate we will hear the term more.

One entity defines a “fiscal plan” as “[a]n outline of the government’s revenue and expense projections.” In Alaska, however, that definition is only partially complete. There are two other elements that I believe are important to a complete defintion here. One is is achieving a balance between revenues and expenses. The second is long term. Put together, a fiscal plan is “[a]n outline of the government’s long term revenue and expense projections, designed to achieve balance.“

In some states a fiscal plan can appear more short term in nature. The focus can be on balancing revenues and expenses over a narrow, one to two year, timeframe. As I have explained in another piece on these pages, that largely is because those states rely on renewable sources of revenue to balance their budgets. Thus, as long as the budgets remain in balance currently, spending levels today do not adversely affect spending levels tomorrow and projections of balance in near term years can be taken as a valid projection of continued balances in later years.

Alaska, however, is significantly different. Alaska does not rely on renewable sources of revenue to balance its budget. Instead, as I describe in the other piece Alaska relies almost entirely on revenues from oil, ultimately a depleting resource.

The result is that its not appropriate to look at an Alaska fiscal plan in just one or two year increments. Instead, Alaska’s fiscal plan has to be evaluated over an extended period, both currently and as oil production (and revenues) decline.

Click on graphic to expand.

The failure to do that, and focus instead only on the near term, leads to significantly distorted perceptions. The chart on the left, taken from a 2011 paper published by the University of Alaska’s Institute of Social and Economic Research (ISER), reflects what passes for, in effect, as Alaska’s current fiscal plan. On the chart, projected revenues — almost entirely from oil — are represented in green, spending is represented by the black line and draws from Alaska’s Statutory and Constitutional Budget Reserves are represented in yellow.

The chart shows that, by drawing from the two Budget Reserves, Alaska is able to continue to finance current spending until roughly 2023, when the Budget Reserves are spent. At that point Alaska drops off the fiscal cliff into the abyss. Once that occurs, the state will be able to provide only one-half(roughly, $4 billion v. $8 billion) of the goods and services it had just two years before, and the level of state services will continue to decline from there.

By focusing only on one, two or indeed five years, some might say that Alaska is in “good” fiscal condition, in the sense that, with the help of the Budget Reserves, the state has the cash currently to be able to pay not only for current, but indeed, increasing levels of spending.

In the long term, however, that view is incredibly short sited. Viewed over the longer term, Alaska’s current fiscal situation — its current fiscal plan — is nothing short of a ticking time bomb, designed to go off precisely when future generations — what some have termed the post-Prudhoe generations — need the continuing revenue stream most.

Alaska’s future doesn’t have to be this way. In another recent paper, ISER’s Scott Goldsmith has outlined an alternative fiscal plan that accounts for Alaska’s reliance on a depleting resource as its revenue base and achieves — as required by the definition — fiscal balance, not only over a short time horizon, but in virtual perpetuity.

The key to that plan is to recognize that Alaska’s current revenues are resources which need to be used to meet the needs not only of current Alaskans, but also future Alaskans. In short, because oil is a depleting resource, both current and future Alaskans need to be supported from the current revenue stream if both population segments are to be treated equitably.

The ISER plan handles that obligation eloquently, by contributing current savings to the Permanent Fund and increasing the level of the Fund over the next few years by restraining spending (but without eliminating the Permanent Fund Dividend). Through doing so, the Fund becomes an investment “nest egg” from which future earnings are sufficient to sustain state spending at a relatively constant level, adjusted for inflation, permanently into the future.

In other words, the approach transforms Alaska from a state dependent on a depleting resource — oil — into one tied to a renewable resource — financial investments. In the near term the approach also increasingly insulates Alaska’s economy against the vagaries of oil price, by connecting it more to investment yields earned by the Permanent Fund. In the longer term, the approach provides a stable revenue source even in the face of declining oil production.

The alternative plan is not without its challenges. Implementing the plan requires reducing spending levels now, so that more can be put into savings to increase the returns received by future generations.

Somewhat surprisingly, however, the required reduction in current spending is not dramatic compared to historic levels. According to ISER’s most recent study, current sustainable General Fund spending levels are in the range of $5.6 billion, exclusive of accounting for Permanent Fund Dividends. This is well within the levels realized during the first four years following the passage of Alaska’s Clear and Equitable Share (ACES), when average General Fund spending was only in the range of $4.5 billion.

ISER’s sustainable level, however, is significantly lower than the two most recent state budgets and those projected for the future. Although atypical historically, the two most recent state budgets have clocked in at $6.7 billion (FY 2012) and $7.6 billion (FY 2013), driven largely by the two highest capital budgets ever approved in Alaska.

And, now having reset the bar, this trend is projected to continue. In an analysis prepared at the end of this year’s special legislative session, Office of Management and Budget Director Karen Rehfeld projected General Fund spending levels averaging $7.24 billion over the next five years.

If that indeed is the future, Alaska’s “Fiscal Plan” will continue to look a great deal like the graphic above — an historically short period of effectively unrestrained spending followed by a deep and lasting dive off the fiscal cliff into the abyss below.

If, however, Alaska’s Governor and legislators are able to restrain themselves and return to spending levels they found sufficient only two short years ago, the future likely will look much different. Alaskans of future generations will remain permanently thankful that Alaskans of this generation took the time and made the effort to adopt a “Fiscal Plan” that works for both.