Juneau, Alaska

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7 Circulating Ideas that Change the PFD – PFD: Part 4

We spent last month exploring some of the dynamics of Alaska’s Permanent Fund Dividend (PFD). We looked at a hypothetical perspective of equal partnership between the People and the Government. Then we evaluated how the numbers we see today are influenced by decisions from our past. In part 3, we took a closer look at the issue from the vantage point of resource ownership.

All this builds off previous looks at how the PFD can be viewed in different ways; how some people see the programs as an entitlement; how the program is more about sharing the wealth than about stimulating the economy; and, how changes to the program could be viewed as a tax. Now we turn our attention to the future.

Like it or not, the PFD program has already been changed. For the last four years, the Permanent Fund Dividend (PFD) formula hasn’t been followed. So, regardless of whether a formal change occurs or not, the historic formula no longer applies.

Because this reality causes political friction, and seeing as the formula is simply a law that can be changed, it appears increasingly likely that a change to the PFD will pass next session. At the very least, the issue will be debated.

PFD Bill

What is not clear is what such a bill will look like. I suspect some changes to eligibility will feature. And perhaps the “50% of royalty” deposits will be revisited.

But the bulk of the focus will be on how much money should be paid out as dividends. The rest of this series will explore a few ways that those changes could be made.

To keep these articles from getting too long, I’ll wait until next week to put some numbers to how these options differ. For now, let’s just understand the universe of alternatives that seem to be up for consideration.

I should again declare that although King Economics Group has a contract with the Department of Revenue and Office of Management and Budget, none of the information on this website is related to, or funded by, those contracts. And, to be clear, we are not endorsing or promoting anything here.

Formula Changes

The law that is currently on the books is nearly 40 years old. While some legislators and many constituents view that law as written in stone, many others are not afraid of making a change to the formula. There are basically two options that are being floated in this regard.

POMV Split

The more popular option appears to be SB103. This bill would change the PFD calculation from 50% of actual earnings to 50% of the POMV limit (other splits have also been discussed).

Basically, this approach removes any direct tie to the annual earnings of the fund. Instead, the Fund balance becomes the deciding factor. This approach does a lot to smooth out fluctuation in available funds, which is further reduced by using a 5-year average of the fund balance. It also alleviates the need for inflation proofing, as the POMV rate is set at a level that already accounts for inflation.

One problem with this approach may be that the POMV rate is arbitrarily set. While this provides stability for distributions, and likely allows for growth of the Fund, it detaches the distributions from actual earnings.

This could result in excessive draws that deplete the fund (if markets are bad for an extended period). Or, it could lead to a situation in which taxes (or budget cuts) are required although investment earnings are robust.

Royalty and Tax Distribution

HB132 is another approach. This bill would completely change the dividend from being a distribution of Permanent Fund earnings to a distribution of oil revenues.

The bill contemplates putting 40% of all annual oil royalty and tax payments into the dividend fund for distribution each year (with a maximum PFD of $1,800 per person).

This is a reversal from the existing situation in which oil royalty and tax payments fund the budget, while the Permanent Fund earnings fund the dividend.

In a way, this approach more closely aligns the resource ownership argument to the distribution amount. So, theoretically, those that view the PFD as a royalty payment from their ownership in the oil may like this approach.

However, moving the calculation away from the Permanent Fund completely may be viewed as turning those assets over to the Government. That creates a lot of resistance. And, including tax payments in the calcualtion changes the dynamic a little bit.

So far, this bill does not seem to have a lot of support. The most voiced objection is that the change ensures the eventual elimination of the dividend (when the oil stops flowing).

It also disarms the “militant ring of PFD recipients” defending the Fund from invasion by those lobbying for more government spending. This puts a question mark on the permanence of the Fund.

Non-Formula Changes

While many people view the 1982 statutory formula as sacred, there are a few ways to change the PFD while still following the current formula. Here are a few.

Distribute Remaining Funds

When the legislature agreed to the proposal by Governor Walker during his last year in office, they didn’t change the PFD formula. Instead, they simply put an upper limit on the amount they could spend from the Permanent Fund each year (regardless of what actual earnings are).

That limit applies to the combination of uses for the general fund and the dividend. It requires that the total draw out of the Permanent Fund cannot exceed a certain “Percent of Market Value” (POMV).

For many people, this appears to create a conflict between the PFD formula and the POMV limit. That occurs by first subtracting the needs for the budget, and then noting that the remaining transfer is insufficient to pay the PFD according to the statute.

One idea to fix this conflict is to formalize the approach. A proposed “first call” provision in the existing law would look something like this:

“AS 37.13.145(b) At the end of each fiscal year, the corporation shall transfer from the earnings reserve account to the dividend fund established under AS 43.23.045, 50 percent of the income available for distribution under AS 37.13.140, however, the transfer to the dividend fund may not exceed the balance of the amount available for appropriation under (b) of this section plus a projection of general funds revenues for the next fiscal year minus the proposed operating budget for the fiscal year

This approach would create this direct conflict between the PFD and the budget (a perceived conflict that already exists). Every dollar of budget cuts would go directly into the pockets of Alaskans (and every dollar of budget growth comes out of their pockets).

Theoretically, this should create a population that is more engaged in the budget process. Of course, the social dynamics prove to be pretty interesting in practice.

Raise the POMV Limit

The above approach effectively gives the budget a first call on the POMV transfer. Another perspective is to subtract the PFD formula first, and then note that there is a deficit in the general fund that must be addressed. From this vantage point, the POMV and PFD statutes do not technically conflict, but a problem still exists.

One option to solve this problem in the short-run is to raise the POMV limit (or eliminate it completely). Doing so allows the “full PFD” and “full budget” to both be paid from the fund earnings.

Of course, this would imply larger draws from the Fund. Unless the fund earns a better return than currently projected, this should raise concerns about the sustainability of this approach.

Use “Real” Net Income

The current formula says to distribute 50% of net income as a PFD. But, the “net income” may not be what you think it means.

To determine “net income” the statute says to add up all the “realized” gains from the last 5 years and multiply that by 21%. From that, half goes to the PFD and half goes to other uses.

One of those other uses is “inflation proofing” the Principal Account. But, let’s take a simplified look at the problem this creates.

Say the fund of $65 billion grows by $2 billion (3%) in a year that experiences 3% inflation. This means that the Fund needs to grow to $67 billion just to have the same purchasing power as it did the year before.

If we distributed half of those “nominal” earnings as a PFD ($1 billion), the value of the Fund can’t keep up with inflation. Might it make sense to protect the Fund from inflation first, and then distribute half of the “real” earnings?

To do this, we would simply change AS 37.13.140(a) to deduct an amount needed to offset inflation as part of the net income calculation. The actual PFD formula would remain the same.

Exclude ERA Earnings

Because the PFD is calculated based on total fund earnings, holding money in the ERA results in a larger PFD calculation.

In the world we are living in today, the ERA is being treated as a savings account rather than a holding account. This is different than the original intent of the ERA, which was supposed to simply hold earnings for future dividends that are not distributed in the year they are earned (due to the “averaging” rules).

If the money is being held as a savings account, one option could be to change the net income rule to exclude ERA earnings. This would reduce the PFD calculation without changing the way it is calculated.

The bill would be a simple one. Just strike a single line from AS 37.13.140(a)

“(a) Net income of the fund includes income of the earnings reserve account established under AS 37.13.145. Net income of the fund shall be computed annually as of the last day of the fiscal year in accordance with generally accepted accounting principles…”

Move Retained Earnings Out of the Fund

A final non-formulaic change would be to stop treating the ERA like a savings account. If the legislature wants to maintain access to those retained earnings, they could move those funds to another account which does not contribute to the PFD calculation.

The most obvious place to move those funds would be the Constitutional Budget Reserve. Of course, doing so would have political challenges. And, a change to the CBR asset allocation would need to be made to avoid income loss.

A less obvious option is to pay off State debts. This has the double advantage (if reducing the PFD is a goal) of both reducing future PFD calculations without changing the formula, and reducing the State budget by ameliorating debt service payments.

Paying down the unfunded pension obligation is perhaps the best way to achieve this. Right now the $8 billion needed to pay off the unfunded obligation is sitting in the ERA earning about $500 million each year.

Most of that money effectively gets transferred to the PERS/TRS retirement account through the budget process each year – as “state support” for the unfunded portion of future obligations.

By moving that money to the retirement account in a lump sum, the earnings on that money still pay down the future obligations, but it removes over $400 million per year from the State budget. Both of which would improve the State’s credit rating.

This option requires no legislation, other than the inclusion of a transfer in the appropriations bill. However, this is probably the least likely option to pass due to the fact that decisions are usually based on political perceptions, not math.

Constitutional Amendment

It should also be pointed out that the Governor introduced a resolution to enshrine the PFD in the constitution. Although not an actual change to the calculation, this would remove the ability for the legislature to appropriate an amount other than what the formula demands.

However, the legislature could still tax the PFD payments. So, be careful not to assume receipt of a “full” PFD is guaranteed if it is in the constitution. Of course, this would force the use of the PFD for government services to be an explicit tax rather than an implicit one (if you subscribe to the owner revenue idea discussed in part 3).

So far, the legislature has not been willing to move on this resolution.

Coming Up

Next week, we will explore how these alternatives compare to one another mathematically. I apologize in advance for the wonkiness that is forthcoming.

While it won’t be a definitive answer on which option is best, it should provide some light on how those options compare to one another. It will be up to you to decide which trade-offs you prefer to make.

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