Technically, the Alaska Permanent Fund Dividend (PFD) is a distributed share of the earnings generated by the Permanent Fund. But the dividend has been called a lot of things lately.
Some people call it compensation for the sale of resources owned by Alaskans. Some people think of it as a government entitlement program. Some think of it as compensation for the challenges we endure as Alaskans. Others think it’s an experiment in socialism.
Whether you consider the PFD to be a government handout, or a source of income from something Alaskans own, really depends on how you view Alaska’s resource ownership and government in general.
The departure in logic stems from why you think it was desirable to create the Permanent Fund in the first place. For whatever underlying purpose, I think we can all agree that it was a way to shift some of the excess cash flow that occurred when oil started flowing, into a time when those oil revenues will stop coming in..
Who Owns the Resources?
In 1959, when the Federal Government created the State of Alaska, they did something unique. They conveyed the subsurface mineral rights on all land they transferred to State ownership.
To some people, this means the State government owns the resources. That is, the nebulous, faceless, ever-changing entity that provides services and writes laws. If you take this view, the sale of resources is a form of revenue to fulfill the mission of the government. Let’s call this the “Government Ownership” approach.
But there is another way to think about this. Some people consider the “government” to be nothing more than an instrument of the people; its assets owned by its residents. From this view, each resident is an equity owner in the government – the legislature acts as its board of directors, the governor as its CEO, and the people as the shareholders. Let’s call this the “Commonwealth” approach.
Let’s look at these two vantage points (from an economics perspective) and see how they lead to different conclusions about the PFD and how to optimize the use of the Fund to accomplish the goals that arise out of these views. I’m not going to take a position on which view is correct. I just want to point out that the view you take will determine the conclusion to which you arrive.
I am sure there are other views out there and I would be happy to consider them if you leave a comment. But for now, let’s assume most people’s beliefs can be placed into one of these camps.
Government Ownership Approach
Naturally, one following this logic would believe that paying for the services the government provides comes first. Payments directly to people would be viewed as a government program; a program that should be cut when it can no longer be afforded. The Permanent Fund must then be viewed as a “rainy day fund”. A place to store excess cash until the government needs it in the future.
The primary goal for having a fund under this view would be to avoid future taxation, as the resource revenues replace the need for a tax. And the dividend? That is just a way to keep the people engaged in a government that doesn’t need their tax dollars.
From this view, we can think of the State’s finances sort of like an individual’s. There is a time in which we experience higher rates of income (career), followed by a time when we can longer expect those revenues to flow (retirement).
The goal is to ensure that we don’t have an abrupt change in our standard of living. So, we sacrifice some of the things we could do with that income today and save it to support us in the future.
In personal finance, we call this “consumption smoothing”. Basically, we live at 80% of what our incomes could support today and then live a similar lifestyle after retirement (thanks to the magic of compound interest).
If we save too little, we end up having to drastically reduce our quality of life in retirement. If we save too much, we end up having sacrificed our happiness without any real gain (although our children will appreciate the inheritance).
For the State, the goal would be to smooth government services over all time. It is a balance of the present and the future. To do so, we would want to solve this equation:
Current (Services – Taxes) = NPV Future (Services – Taxes)
where Taxes = (Total government spending – Total Revenues); and where the PFD is a component of government services.
If you take the alternative perspective, the Permanent Fund becomes more like an irrevocable trust. Putting the future’s share of the resources in trust until they are ready to accept it. The PFD becomes a distribution of ownership to the current beneficiaries, while the principle is protected for all future Alaskans.
In reality, if this is your position then every dollar that is generated from those resources belongs to the people. Which also means that the tax avoidance we receive in order to get the government services we desire are themselves distributions of our resource ownership. That implies that any oil money that is spend on government is a tax, by definition (a compulsory contribution to state revenue from an entity’s revenue).
If we believe that those resources should be equally distributed to all Alaskans – past, present, and future – then we can’t distribute all the money to the current residents. We would have to put some of that money aside for those Alaskans that have not yet been born.
If this is your view, your optimization problem looks like this:
Current (Services + PFD – taxes) = NPV Future (Services + PFD – Taxes);
Where PFD = (total oil revenues + PF earnings); and
Where Taxes = Total Spending – Total Non-Tax Revenue; and where Fund earnings and oil revenues are not considered government revenues.
This optimization problem suggests that all oil money should be treated as belonging to the people, and should be distributed to them over time. And, all government services are paid with taxes. Either traditional broad-based taxes, or via reductions to the PFD.
In both views, the concern should be “what happens to future generations as a result of our actions today?”
While the optimization equations are different, they can be simplified to be basically the same. The only real difference is how the PFD is viewed, which creates a different need for taxation. In the former view, the PFD is the first to go. In the latter, it is the last.
Fund Growth as a Goal
I’ve heard people fantasize about our fund becoming as large as the trillion-dollar fund in Norway. Imagine for a moment that we did. A trillion-dollar fund would generate earnings more than $50 billion a year (maybe even $200 billion in some years). Our State government currently spends about $6 billion a year to pay for the government services we currently enjoy and the PFD.
What would we do with the other $44 billion? Would we connect all our communities with roads and an intrastate power grid? Would we give each Alaskan a $70,000 check each year? Would we have indoor soccer stadiums in every school, free college tuition, and universal healthcare? Or would we just have an ever-growing bank account we can show off at cocktail parties with our sovereign friends?
And is that rich future worth the efforts that it took to achieve it. Are we willing to eliminate the PFD, pay taxes, and restrict government services for the next two generations so that future generations reap the rewards?
The point is that fund growth itself it not a good goal. We need to be growing the fund toward some target. We must find a balance between the present and the future. The most logical balance is to seek intergenerational equity; saving just enough so that the future can have the same opportunities as the present.
Our goal should not be fund growth, nor should it be depletion of the fund. Instead, we should look at the remaining oil revenues and decide how much of those need to be saved in order to allow the future to live a similar life as we do now. And we need to take responsibility for any budget deficit that creates. Failure occurs by spending too much, but also by saving too much.
Are We on Track?
If we pay the current statutory formula, maintain current spending levels, and don’t impose any taxes, what does that do for the future? Well, we did the math in previous article.
Because the Fund is not large enough to generate earnings sufficient to pay the current dividend formula, fund the budget deficit, and inflation proof the fund, the fund balance will shrink in real terms. As a result, we can expect that future generations will have a reduced quality of life compared with the current generation. They will face some combination of reduced services, smaller PFDs, and some form of tax.
On the other hand, if we eliminated the PFD, imposed a 3% income tax, and cut government services by 20%, what does that do for the future? Well, we can do that math too.
What you would end up with is a much larger Permanent Fund balance spinning off larger earnings. These larger earnings would support larger government projects and eliminate future taxes. So, the current generation would be sacrificing for a better future than the present.
Solving the Optimization Equation
Finding the balance is something that can be calculated. A good probabilistic model that incorporates oil price and production uncertainty, as well as future budget needs, is something a good economics group could do (especially if they specialize in strategic decision analysis).
You could then optimize the draw rate today so that the net value of the future and current generations are equal in real terms (hint: one solution is a 6% POMV with half going to the PFD). Naturally, you would need to re-run the model each year to incorporate new information and changing circumstances.
How you split the earnings between spending and dividends is another issue altogether. An issue that starts with how you prioritize the PFD and what size of government you believe to be the “right size”.
There are an infinite number of combinations that work. But, each will have different impacts on different groups of people and the economy at large. You could cut the dividend and maintain government at its current level. You could cut government and leave the PFD at the current level. You could leave both the government and the PFD at current levels, and implement a tax. Or you could do any combination of those options.
Your own beliefs of what is best is going to flow from your views of the PFD, your income level, your political beliefs, and where you live. For example, If you’re most interested in job creation, keep taxes to a minimum. If you care most about social equality, protect the PFD and government programs. If you live in an area dependent on government jobs, protect the budget. If your goal is maximizing total economic activity, get as much money as you can into the hands of those that will spend it (keep the PFD as high as you can).
As we pointed out before, the current version of SB 26 probably goes too far. While setting the structure up in statute is a good starting place, the optimization effort is probably lacking. We recommend a continuous effort to analyze this issue rather than a belief that passing this legislation solves the problems.
Each new legislature should consider future revenue projections from an independent unbiased source. They should then recalculate the appropriate draw rate to achieve intergenerational equity. With all this new information, the legislature should make adjustments accordingly.