The leadership of the Alaska House of Representatives introduced a piece of legislation on March 5th that would fundamentally change the Permanent Fund Dividend (PFD). The House Finance Committee will be taking up the bill this week. If you would like to provide your thoughts on the bill, public testimony is scheduled for Thursday, March 12th, at 1:30pm.
The bill mostly does two things. First, it switches the definition of how much money is available from the earnings reserve account (ERA) to pay the PFD. Rather than adding up the last five-years worth of gains, subtracting the earnings that are unrealized, and multiplying that number by 21%, the bill would switch to the POMV approach to determine the PFD and the maximum transfer from the ERA. As I have written before, this is a welcome and necessary change to align the definitions now that we are committed to the POMV.
Second, the bill changes the split between the PFD and the general fund. Rather than being a 50/50 split, the general fund would now take 80% of the transfer. The other 20% would go out as a PFD. Together, these changes would move the PFD calculation for this October from around $3,100 to about $900.
This provision needs more analysis than I did before. But, it is clear that this approach adopts the most regressive tax strategy available to solve the problem. It also places the burden exclusively on the backs of Alaskans, which is not the most economically efficient approach.
It seems likely that the House will pass this legislation. The PFD issue has been a thorn in the side of the legislature for a few years now. They want to align the law with what they feel they can afford to pay – so that they can disarm the “follow the law” talking point. But, passing a 50/50 PFD split would force them to either break the POMV limit or to break the law they just passed. When the House passed HCR13 and set a $100 billion target, it was a strong indicator that they don’t want to do that.
So, I expect something like this to move out of the House pretty quickly. It is unlikely that they didn’t have the votes counted when the House leadership introduced the bill.
When the bill gets to the Senate, it is unclear what will happen next. Getting 11 votes might not come from the majority, but there may be enough minority support to get there. The PFD issue has divided the Senate since last year and that divide hasn’t went away. Pushing this bill might fracture the caucus further.
A Veto is Likely
Even if the Senate does pass something, the Governor is likely to veto anything that reduces the 50/50 split that is in current law. He might sign the change to using POMV for the calculation, but he ran on protecting the PFD and I have a hard time believing he would retreat far enough to allow a 20% split. It also seems unlikely to me that 40 legislators would override a veto.
The legislature might get cute and condition a PFD distribution on the passage of a PFD law. Such an effort would attempt to force the governor to give us $0 if he vetoes it. However, I am sure he would simply call a special session. Giving no PFD in an election year and spending another month in Juneau during campaign season is not in anyone’s interest.
Which all means that the most likely outcome seems to be another ad hoc PFD. I’m guessing it ends up being under $1,000. It would probably have been more if not for the damage the Coronavirus has done to our financial picture.
Let’s explore how the PFD changes under this proposed law. According to the current law, the PFD is effectively calculated as 10.5% of the statutory net income earnings from the previous five years. But, is it unlikely that the formula currently in law will ever be followed again. Ever since Governor Walker vetoed half the PFD in 2016, and the Supreme Court decided that he was allowed to do it, the law has become hollow.
If the law stays on the books, the most likely outcome is that the legislature would continue to distribute an amount it thinks it can afford rather than a structured amount. Looking at the state’s revenue outlook, budget growth projection, and fund earnings expectations, the baseline estimated payments would look more like this:
Under HB306, the PFD calculation is permanently reduced to 20% of the POMV limit. Here are the PFD calculations under this new law compared to the status quo assumptions:
For the next few years, HB306 generates larger PFDs than an ad hoc approach suggest would occur. However, that assumes that the new law would be followed. To do that, a different assumption would need to change. Either the budget would not grow with inflation, some other form of revenue would be raised, or additional savings draws would be required. More likely, the new law would be broken or the PFD split would get reduced again.
More importantly, the long-term impact is that the proposed calculation generates smaller PFDs than could be paid based on the “leftover” approach. As the fund gets larger, it spins off additional revenues. Add that to decreasing debt service payments and increasing revenues. The result is that the current shortfalls in revenues become less severe over time – even under the baseline assumptions.
But, HB306 treats the problem as though it is permanent. As a result, the government ends up with more revenues than it needs to balance the future budgets – even with inflation adjustments. That fact is likely to result in more spending. As such, HB306 could end up being a backdoor approach to diverting some future PFD money toward growing the size of government.
Higher Production Case
Now let’s change the baseline assumptions and see what happens. Let’s assume that the Pikka, Willow, and other development opportunities currently being evaluated move forward. With this alternate production assumption in place, here is how the PFD payment would play out under the current law versus HB306.
You might notice that the numbers are close in the next several years. That is because the 20% number is designed to solve the near-term problem. However, it does not consider the long-term outlook. As you can see, if all of the excitement on the North Slope today turns into production, the current law and available revenue would allow sizable PFD payments in the future.
Under the proposed law, the money that would go to future PFDs payment won’t enter the PFD conversation. It probably ends up funding a bigger government instead. It’s one thing to cut the PFD when there is no money, but the proposed law cuts it regardless of affordability.
A close observer will also notice the HB 306 distributions are larger under this production scenario. That is because more production equals more royalty deposits into the Permanent Fund. Resource development is still an extremely important part of our financial future.
One of the problems with most projections is that they either use static assumptions or they use average values. That is fine for building baseline assumptions, but no static financial plan survives first contact with volatility.
It is important to understand how swings in oil prices and investment returns play out. So, here is one randomly generated outcome to give us a flavor of what reality could look like.
With oil prices and stock market values jumping around every day, there is always volatility in the budget and the PFD. Now that we are at a place in which falling oil prices result in PFD cuts, the dividend faces direct volatility from both markets. As you see in the graph above, there will be years that oil prices spike and a bigger PFD is “affordable.” There will also be times that crude prices tank and paying any PFD at all will be hard (we are there now).
With the POMV approach, that volatility is greatly reduced. So, there is merit to the general idea. It’s just that the number needs to be set at the right level and then left alone. If the new approach consistently generates smaller payments than are affordable, and if the times that would allow bigger checks turn into more government instead, there is something wrong.
Changing the PFD calculation to align with the POMV formula is probably a positive path forward. However, changing the PFD split is more difficult to assess. Given the uncertainty about future market conditions, it is not clear what the correct percentage should be. Part of the problem is that the goal is not well defined.
It appears that the 20% figure was derived to balance current market conditions. However, that neglects to consider what future needs will be. Given the willingness to reduce the split, that could put the PFD on a slippery slope toward elimination. And, because the reduced PFD solves future deficits, it results in the legislature abdicating its responsibility to thoughtfully pursue the public interest. The question of the best way to solve the problem is not one that should be brushed aside with a permanent PFD reduction.
It also fails to consider the possibility of success. In situations that result in increased oil development, the 20% number is too low. We again reach the same conclusion as previous analyses. We cannot know if this approach will be successful until we know what it is trying to achieve. But, the effort to reduce the PFD split to 20% will ultimately result in smaller dividends and a step toward the elimination of the program. Unless that is the goal of the legislation, there are better ways to manage the state’s financial shortcomings.