Why Alaska Needs to Reduce State Spending (and how to do it) (from the October 2013 Alaska Business Monthly)

In addition to pieces on this page and elsewhere, I write a monthly op-ed column on oil, gas and fiscal policy issues for the Alaska Business Monthly.  The following piece was originally published in the October 2013 print edition and is available online here.

Based on state Office of Management and Budget data, over the last decade annual state government general fund spending—operating and capital combined—has nearly tripled, from roughly $2.3 billion in FY 2004 to a now-projected $7.1 billion for FY 2014.

Over the same period, the Consumer Price Index (CPI) has only increased by 27 percent. That means increases in state spending over the period have outstripped the CPI by roughly eight times.

The escalation has been substantial even when measured only over the last five years, since Governor Parnell took office. Alaska state general fund spending over that period alone has increased by approximately 40 percent, from roughly $5.1 billion in FY 2009, the last budget prepared under Governor Palin, to $7.1 billion for FY 2014.

During the same period the CPI has only increased 6 percent.

As I have discussed in this column before, earlier this year the University of Alaska Anchorage Institute of Social and Economic Research (ISER) had this to say when looking at these trends: “Right now, the state is on a path it can’t sustain. Growing spending and falling revenues are creating a widening fiscal gap … Reasonable assumptions about potential new revenue sources suggest we do not have enough cash in reserves to avoid a severe fiscal crunch soon after 2023, and with that fiscal crisis will come an economic crash.”

Importantly, that analysis was based on projections which assumed the continuation of ACES (Alaska’s Clear and Equitable Share), the former oil tax law that almost all now agree took too much of the North Slope revenue stream and subsequently has been supplanted.

Alaska is not facing a revenue problem, it is facing a serious—and potentially soon—catastrophic spending problem of its own creation. In short, Alaska is careening toward a crisis, not attributable to “federal overreach” or any other Outside force, but entirely created by the state’s own inability to control spending.

What Is Going On?

When confronted by these facts readers may ask: “Why has spending risen so quickly and so much?” The answer is simply that government has spent more—and then more—through both the operating and capital budgets.

In FY 2004 the operating budget was $2.23 billion. For FY 2009, the operating budget was $3.38 billion. For FY 2014, the current fiscal year, the state operating budget provides for $5.3 billion in spending.

In short, in ten years the operating budget has increased by over 135 percent; in the last five years alone it has increased by in excess of 50 percent.

Some attribute the substantial growth in the operating budget over that period to increases in formula driven programs, those that are on a type of automatic pilot and whose spending levels are set by formulas established either in federal or state law.

Those type of programs certainly have contributed. Combining formula driven funding for education with other formula funding, that category of spending has grown from $1.1 billion in FY 2004, to $1.6 billion in FY 2009, to $2.7 billion for FY 2014.

But on a percentage basis that category has not grown any faster than the remainder of the operating budget.

What has grown faster, and promises to continue growing at an accelerated rate going forward, is the required state contribution to the state’s two pension systems, PERS (Public Employment Retirement System) and TRS (Teacher Retirement System). From not even being listed as a line item in FY 2004, the required contribution grew to $104 million in FY 2009, and subsequently has grown to $633 million for FY 2014, accounting for approximately a quarter of the growth of the operating budget over the same period.

Recent studies estimate that category of spending alone will rise in the next three years to, and then continue for several years at over, $1 billion per year.

The capital budget, while easier to control, apparently also is easier to let get out of hand. In FY 2004, the capital budget was $84.6 million. In FY 2009, the capital budget was $675.3 million. In FY 2013, the recently completed fiscal year, capital spending rose to a staggering $2.1 billion, a level which is nearly twenty-five times the level of spending just ten years ago.

Including so-called “fund capitalizations” (a new category), the capital budget for FY 2014 is $1.83 billion, slightly less than the record level of FY 2013, but still higher by orders of magnitude than the levels from five and ten years before and a substantial contributor to the building crisis described in the ISER study.

What Needs To Be Done to Avoid the Coming Fiscal Storm

What can be done to avoid the coming fiscal storm? The ISER analysis is clear: “The answer is to save more and restrict the rate of spending growth. All revenues above the sustainable spending level of $5.5 billion … [sh]ould be channeled into savings.”

But how can state spending be reduced to the “sustainable” level of $5.5 billion? The ISER analysis does not reach that issue, but working through past state budgets and fiscal policy demonstrates that it’s not rocket science. In fact, I think it can be done in three steps.

Step 1: Return Spending to FY 2011 Enacted Levels

The last time the Governor and Legislature enacted a budget within sustainable levels was in 2010, for FY 2011. The first step in returning current spending to sustainable levels is to return to that budget level—one which the state found sufficient just three short years ago.

The FY 2011 enacted budget authorized $5.48 billion in state spending, a level within the $5.5 billion “sustainable” level outlined in the ISER report. The operating budget for that year was $4.84 billion; the capital budget was $643 million.

While this coming year’s operating budget is $450 million higher than the FY 2011 level, that difference amounts only to roughly 8.5 percent of the current operating budget. While they will require prioritization, cuts in that range—especially since they will return the budget to levels that worked only three years ago—are certainly achievable.

One challenge in that effort, of course, will be accommodating the necessary growth in the PERS and TRS contributions within that ceiling. The PERS and TRS contribution in FY 2011 was $357 million. As noted previously, the required contribution included in the FY 2014 budget is $634 million, and is forecast to continue rising over the next two decades.

There is ample opportunity for offsetting cuts in the capital budget, however. The FY 2011 capital budget was $643 million. While that is significantly lower than the capital budgets the last two years, it is nonetheless higher than the historic average over the last ten years. Coming off successive years of record capital budgets, the state easily can afford to take a breather and reduce capital spending to levels more in line with the historic average in order to offset any required additions over FY 2011 levels to the operating budget.

Step 2: Set Aside Future Alaskan’s Share of State Revenues Off the Top

In the August issue of Alaska Business Monthly, in my column titled “Is This Generation of Alaskans Failing the Next?” I explained that the revenue stream received by state government today actually comes in two parts. A portion of it is for the account of, and can be spent by, the current generation of Alaskans. Because it is a monetization of a depleting resource, however, a portion of the current revenue stream also is for the account of future generations.

This generation has an obligation to hold the portion of current revenues attributable to future generations in trust. Put in simple terms, that means this generation has an obligation to save it, and not spend it on ourselves.

As I also explain in that column, however, in my view this generation is violating that obligation, by spending today from the amounts properly attributable to our children, grandchildren, and those that will follow them.

As a consequence, a second step in avoiding the coming fiscal storm is to recognize what we are doing and start setting aside, before calculating the amount of revenues current state government has to spend, the portion attributable to future generations. In other words, as most of us do in our own private lives, we should save the portion of the state’s earnings that is attributable to future generations, before spending the remainder on ourselves.

Applying the approach I suggested in the earlier column to the Department of Revenue’s recent forecast of anticipated revenue levels for FY 2014 would result in the state setting aside roughly an additional $900 million during the current fiscal year for future generations and would reduce the level of revenues available for this generation to approximately $5.8 billion.

One of the problems the Governor and legislators sometimes face is the public perception that state government has a lot of money to spend. More accurately stating the level of revenues that government has available to spend on the current generation makes a sustainable budget target of $5.5 billion far more explainable.

Step 3: Eliminate Earmarks

Readers are likely to recall the efforts earlier this decade at the federal level to eliminate Congressional earmarks. As the Wall Street Journal put it at the time in editorializing against the practice, “It’s true that earmarks make up only 2 percent to 3 percent of all federal spending, but that spending is what greases the political skids for passing trillion-dollar-plus budget bills. Members get what they want in return for voting ‘aye’ on what the Administration and Congressional leaders want.”

While Congress subsequently eliminated the practice, Alaska state government has not. From using state funds to subsidize airplane tickets to the Great Alaska Shootout, to paving parking lots for privately owned sports facilities, to building tennis courts in Anchorage, Alaska state legislators continue to engage in the same earmarking practices as their Congressional counterparts earlier did.

And, although on a smaller scale, the practice produces the same end result. By providing individual legislators with the right to earmark state funds for specific projects, the Governor and legislative leaders help grease the skids for gathering the votes necessary to pass billion-dollar-plus budget bills.

While Congress still has not turned the corner, it nevertheless has slowed the growth of the federal budget crisis—and forced members increasingly to come to grips with the larger fiscal issues—by eliminating earmarks. Alaska should do the same.

Bradford G. Keithley is the President and a Principal with Keithley Consulting, LLC, an Alaska-based and focused oil, gas and fiscal policy consultancy he founded. Keithley also publishes the blog “Thoughts on Alaska Oil & Gas” at bgkeithley.com.