Alaska’s true fiscal picture …

Last Friday, the Department of Revenue issued the Spring 2015 update to the Fall 2014 Revenue Sources Book (RSB).  Among other things, each year the Fall Book contains a forward look at the revenue portion of the state’s fiscal condition over the next 10 years.  As the legislature and Governor finalize the upcoming year’s budget, the Spring update revises that forecast, usually focused on the next two years, for known and measurable changes occurring since the Fall forecast.

While DOR adjusted the first two years at the time it issued the Fall Book, the oil prices contained in the Fall Book largely were set last October, before the full outlines of the 2015 oil price plunge were known.  As a result, while the Fall Book gave observers a feel for where Alaska’s financials were headed the next two years, the primary forecasts contained in the Fall Book did little to provide a realistic picture beyond that.

The Spring update starts down that road by revising the oil price forecast across the same ten year period as the Fall Book.  While some, including me, may argue that even the Spring update paints too rosy a picture of future oil prices — for example, the Spring update forecasts the FY 2022 oil price to average at around $102; as of this writing, the current futures market prices for the same period level out at $77 (Brent) and $66 (WTI) — it nevertheless is a more realistic picture than derived from the Fall Book.

But there is a larger issue at stake here.  As with their predecessors, both the Fall Book and Spring update continue to focus mostly on oil when viewing Alaska’s fiscal future.  Increasingly it is clear that is an incomplete view.

Over the past, now approaching four decades, Alaska has become a two-income family.  The oldest and historically strongest income stream has come from oil (with some assist from what the Fall and Spring books refer to as other, “Non-petroleum revenue”).  But creeping up on the outside over the years has been investment income, produced from Alaska’s financial assets.

When asked, Alaskans tend to think of this second income stream as tied to the Permanent Fund and constitutionally protected.  That is true to some degree, as it also is for oil.  Under Art. 9, Section 15 of the  Constitution, “[a]t least twenty-five per cent of all mineral lease rentals, royalties, royalty sale proceeds, federal mineral revenue sharing payments and bonuses received by the State shall be placed in a permanent fund ….”  Constitutionally, only the remainder of the oil stream is available to the general fund.

Similarly, part — but only part — of the state’s investments are constitutionally protected from the general fund.  Under the same provision of the Constitution, “the principal of [the permanent fund] shall be used only for those income-producing investments specifically designated by law as eligible for permanent fund investments.”  The Constitution goes on specifically to provide, however, that “[a]ll income from the permanent fund shall be deposited in the general fund unless otherwise provided by law.”

Since the passage of the constitutional provision, the legislature rightfully has provided statutory protections for a portion of that income stream, such as to cover the dividend and to provide for inflation proofing the Permanent Fund.  That has the effect, in the same way as the Constitutional provision dealing with oil revenue, of setting aside a portion of the earnings stream outside of the general fund.

But as with oil, the remainder of the investment income, together with the investment income from most of the state’s other financial assets, remains available to the general fund.

Just as in any two-income family, the fact that you have two incomes doesn’t mean you spend it all.  Some needs to be set aside for future needs — in a personal setting, such as college education for the kids and retirement.   Since the inception of the Permanent Fund, most of the state’s second, investment income stream has been set aside for a similar purpose, to help grow the state’s “nest egg” for a time when oil revenues no longer are sufficient alone to cover the state’s fiscal needs.

But most observers have realized that, at some point, as oil revenues decline, the second income stream — the state’s investment income — will be needed to supplement the first.  The question has been when.

Over the past several years, University of Alaska-Anchorage and Institute of Social and Economic Research (ISER) Professor Emeritus Dr. Scott Goldsmith has done a substantial amount of work which helps identify when that point is and, when it comes, in what amounts the state’s second income stream should be tapped.  Referred to by most as a sustainable budget, Goldsmith’s work has calculated — taking into account both the state’s current and future oil and investment income streams available to the general fund — what the amount is that if spent today, can be sustained indefinitely into the future, adjusted for inflation and population growth.

The approach provides an equitable, base share of revenue for each generation of Alaskans.  If any generation concludes that it needs more than its share, it can decide how, and how much to tax itself to produce the remainder, leaving to future generations the ability to do the same instead of being forced to do so because previous generations have taken more than their share.

In short, Dr. Goldsmith has developed a formula which calculates and identifies a level of draw from both of the state’s income streams that produces a sustainable and secure fiscal future for all Alaskans, those in both Alaska’s current and future generations.

Going forward, the state needs to present a better picture of Alaska’s overall fiscal position in the annual Fall and Spring books than it does now, so that Alaska’s leaders, and Alaskans themselves can have a clearer picture of the state’s current position and fiscal way forward.

Both the Fall Book and Spring update should explicitly include both the portion of investment income available to the general fund as part of the revenue stream and a prominent calculation of the sustainable budget number so that Alaskans know what the limit should be on spending.

That will bring a new — and much more reasoned — perspective to both the state’s current situation and its future.

For example, looking at the current Spring update (Table 2-1, p. 3), it appears that the state’s general revenue for FY 2016 is limited to $2.216 billion, and that the projected revenue stream for FY 2017 ($2.198 billion) is even worse.  Using that as a base, some legislators already have started talking about the need for income taxes and a diversion of a portion of the Permanent Fund Dividend to fund continued government spending.

But taking into account both income streams and looking at Alaska’s fiscal structure from a sustainability perspective paints a much different picture.  Based on those criteria, Dr. Goldsmith calculates that Alaska’s current sustainable level of revenue is approximately $4.5 billion (or more than twice what legislators are telling themselves), without resorting to additional taxes above current levels or the diversion of any portion of the PFD. 

Using that analysis it is clear that the rush by some legislators to taxes and a diversion of a portion of the PFD is misplaced.  While a limited amount of supplemental revenues may be needed if Alaskans truly believe government spending needs to exceed $4.5 billion, there is nowhere near the revenue gap, for example, that formed the basis for the analysis given to the legislature at the recent House Finance Committee sponsored “lunch and learn” or that others have derived from the Spring update.

Frankly, I believe that Alaska’s best days lie ahead, not behind.  Unlike any other state, by adopting a sustainable budget approach Alaska has the ability to fund government indefinitely into the future, without the need for additional taxes or a diversion of the PFD.  In many respects, there is an opportunity to realize a Morning in Alaska, just as President Reagan outlined for the nation in 1984.

But to realize that opportunity Alaska has to start providing itself with a true fiscal picture of its condition, not one where it only counts one of its revenue streams.  Otherwise, by painting a distorted picture of its fiscal condition, Alaska’s leaders will only make it worse, by chasing down the rabbit hole of identifying and capturing new revenue streams that will damage the private economy at a rate much worse than they make the government economy better.