The (much) better economic model for #AKFuture …

ISER Sustainable Budget Model

(Supplemental Note:  Following up on a reader’s suggestion, I published a brief supplement to this piece on 6.15.2015 to make available a couple of graphics reflecting the points made in the following piece.  The supplement is available at “Page Two” of this blog, here.)

Yesterday, after the legislature finally completed work on and passed the coming year’s (FY 2016) budget, I spent a large part of the day working through the two publicly available economic models recently offered to help Alaskans understand and help plot where the state should be headed going forward.

The first I spent time with was that released last weekend as part of Governor Walker’s “Conversations with Alaskans”.  That model is available for download here (*see additional footnote below). 

The second was that released earlier this year by the University of Alaska-Anchorage’s Institute for Social and Economic Research, the best non-partisan economic think tank in the state.   That model is explained and available for download here.

There are significant differences between the two. 

The first is that the model prepared and offered by the Administration at last weekend’s session is very short term oriented.  While it provides users with the option to change the first year price of oil, which thereafter appears to be escalated by the rate of inflation, it does not permit users the additional option of looking forward and adding (or subtracting) levels or sources of oil (or gas) production which may occur in the future.  Those additions are one of the two best sources of new revenue to state government (in the sense they add, rather than take dollars from the private Alaska economy).

Instead, the Administration’s model largely fixes the forward looking oil production curve to reflect the Administration’s own, admittedly conservative view of  future production levels.  That production curve is based largely on estimating future production from existing sources and projects at an advanced stage of development at the time the estimate is made.  It does not include additional projects that are under evaluation and likely to add to state revenues in future years as they are developed.

The effect of excluding the ability to make judgments about and add the consequences of those projects is substantial.  At any given oil price that approach rigidly sets the current and future revenue line, making future deficits look larger and motivating the user to toggle more and heftier “revenue [i.e., tax] options” as they try to close the future gap.

The ISER model, on the other hand, is long-term focused and starts first with enabling users to make judgments about long term oil (and gas) production levels, and thus revenue streams.  Unlike the Administration’s model, it also enables users to make long term judgments about the anticipated before and after inflation adjusted returns from the state’s financial assets — the other future revenue stream that does not take dollars from the private Alaska economy.

While difficult to parse exactly (the model does not provide access to the back up data), the Administration’s model appears to tie the growth of and, thus, returns from the state’s financial assets to the rate of inflation, increasingly understating their potential contribution to future state revenues the longer out in time the user looks and thus, again, making future deficits look larger than they may be.

But there is another significant difference that is even more important.  From the start the ISER model is geared to producing a long term sustainable number — a number to which if spending is limited today, can be sustained (adjusted for inflation and population growth) indefinitely into the future.  That number appears in a big red block on the front sheet of the model and constantly adjusts, real time, as various alternative options are explored.

The Administration’s approach, on the other hand, does not provide such a number.  Instead, it is focused on providing year to year results that, given the limitations on providing realistic long term projections for oil and financial revenues, continually shows significant long term deficits unless hefty “revenue” options are toggled.

The result is that, unlike ISER’s approach, users are left unaware of the options available for calculating and identifying spending levels which are reliable, predictable and sustainable over time from existing revenue sources.  Instead, users are left with the sense that the “other” revenue options, which the Administration’s model discusses at length at a tab labeled “Revenue Option Descriptions,” necessarily are increasingly part of Alaska’s future.

Among other issues, the Administration’s approach is unsettling to potential investors.  When selecting among global alternatives, investors — particularly those, like resource investors, who are evaluating a long term payout on their investments — put a premium on stable, predictable and reliable fiscal regimes.   Given its limitations, the Administration’s approach provides a picture of anything but that, clearly leaving the impression that Alaska’s future will be driven by continual choices between various revenue options, many of which may significantly change the financial outcomes of investments in Alaska.

That is somewhat ironic given this pledge repeatedly made last year during Governor Walker’s campaign:

I will make the hard choices necessary for a sounder fiscal future, including putting in place a sustainable budget. I will make sure the investment climate in Alaska supports those goals, which includes a favorable fiscal climate for citizens and companies investing in our economy.

The course outlined by the Administration’s model is anything but a stable, and thus favorable, fiscal climate for potential investors.  Instead, from that perspective it gives the impression of a state in fiscal decline, increasingly reaching out to identify new revenue options as the fiscal gap continues to widen.

As I have explained elsewhere I believe that Alaska can have a bright future ahead of it — a Morning in Alaska.

But Alaska can only grasp that if it takes a long term view of its future, identifies the long term sustainable level of spending achievable based on its asset base and grasps the opportunity by reducing current spending to that level and then building it back up, based on inflation and population growth and any changes in its long term revenue streams, from there.

Some — including the state’s current Commissioner of Revenue — are fond of saying that the state can’t cut its way to prosperity.  From the perspective of citizens and other investors — which Governor Walker correctly identified as a key during his campaign — the state certainly can’t waffle its way to prosperity.

When asked during his campaign what he meant by a “sustainable budget” then candidate Walker repeatedly referred to the ISER methodology.  My hope is that at some point in the near future he reverts to that and the Administration starts focusing on what a long term, sustainable budget number actually is.  It’s current model isn’t designed to provide that, but that is exactly what investors are looking for the state to identify, and then stick to.

Going forward I will continue to use the ISER model for my analysis.  I would suggest others do as well. ___________________________________________

*As of the time of this writing (6.13.2015), the version of the Administration’s model on the state’s website (“20150607_revenue-and-expenditure-model.xlsx”) appears to have a glitch in it.  When options are toggled which should result in increased revenues (e.g., increasing the price of oil), the “total revenue” line in the “Budget Overview” box (which should reflect the result of the increase) goes up for one year (FY 2017), and then falls back down to the original forecast.  The effect in the next box down (“Fund Changes”) is to show the change as a reduction in revenue rather than an increase.  This appears simply to be a transposition error that likely will be corrected in the next iteration of the model. Until then, however, users should be aware of the issue and adjust the results accordingly.

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