Last week we explored a hypothetical dynamic equity model for the PFD. Of course, the Government and the People are not actually business partners. They are two sides to the same coin.
So, let’s drop the differentiation for now. This week, let’s simply explore how the current PFD calculation would change under different historical actions by our legislative branch.
In other words, let’s dive a little deeper into where that $3,000 number is coming from.
The PFD calculation can be found is Alaska Statute 37.13.145(b). It’s a fairly simple law. It just says that you calculate all the realized earnings of the Permanent Fund from the last 5 years, multiply that by 21% to get the available income for the year, and give 50% of that to the people of Alaska.
The other 50% has always been available to the legislature to use however they deem fit. From 1983 to 2003, they transferred that all of that money to the principal of the Fund.
Then, from 2004 to 2015 they only transferred enough to offset inflation. Whatever was leftover, was held in the Earnings Reserve Account (ERA).
From fiscal year 2016 to 2018, the legislature stopped inflation proofing the principal as well, leaving all excess earnings (and some of the PFD calculated distributions) in the ERA.
Finally, last year, the legislature began using part of these earnings to fund government services. The issue of how much to pay for the PFD is still up in the air, along with many questions about whether the historic formula still works.
We’ll look closer at how that formula can be changed in a later article. For now, let’s just look at how much the current formula changes under different spending/saving decisions.
Money flows into the Permanent Fund in a couple ways. First, the constitution requires that 25% of all mineral royalties collected by the State (including Federal sharing payments) get deposited directly into the Principal Account of the Permanent Fund (this account is off limits to the legislature).
Second, appropriations from the legislature can be made to the Fund. This happens in four ways.
A) “additional royalty deposits” are typically made by the legislature in accordance with AS 37.13.010(a)(2). This is a provision that calls for 50% of royalties from leases entered after 1980, rather than the constitutional 25%.
B) “special appropriations” occur when the legislature has excess General Fund revenues and decides to protect them in the Principal Account of the Permanent Fund.
C) “retained earnings” happen when the legislature decides not to transfer excess earnings out of the Fund, by either transferring them to the Principal Account or leaving them in the earnings reserve account (ERA).
D) “inflation proofing” is the process by which the legislature transfers money to the Principal Account to ensure the value of the deposits are not eroded by inflation.
Retained Earnings Explained
Article 9, Section 15 of Alaska’s constitution states that: “All income from the permanent fund shall be deposited in the general fund unless otherwise provided by law.”
That shall provision means that any income from the Fund that is not used to pay dividends, or transferred to the Principal Account, belongs in the General Fund (this happened automatically prior to 1983).
We get around that rule with AS 37.13.145(a) which directs those excess revenues to the statutorily created “earnings reserve account” rather than the General Fund.
Any balance in the ERA is technically placed there by the legislature through statute (just like a transfer to any other account), and remains accessible to the legislature.
Note: the Alaska Permanent Fund Corporation typically calls retained earnings transferred to the Principal Account “special appropriations.” I consider all excess earnings not transferred out of the Fund to be “retained earnings” here because of the different implication on the total fund balance.
Before we get too far, we need to establish a baseline. We now know that the Permanent Fund earned $3.3 billion in net realized income during FY19 (a $3.8 billion total return, with about $500 million unrealized).
When combined with the last four years’ earnings, the net income available for distribution in 2019 is $3.75 billion. Therefore, the statutory transfer to the dividend fund would have been $1.88 billion.
Therefore, the October 2019 PFD works out to about $2,949 each – if we were paying it using the statutory formula.
So, that “$3,000 PFD” is actually a little less because realized earnings were a little lower than projected for FY19.
That’s our baseline. But where is that $2,949 number coming from?
Before we can really determine how the present would look under different decisions, we need to correct the deviations that were made over the last few years. Otherwise we won’t get a clear picture of the alternate history.
So, let’s start by looking at what things would look like today had the legislature strictly followed the current statutory guidance.
The PFD amounts that were paid over the last 3 years were lower than the formula would have called for.
|Year||Statutory Distribution (billions)||Amount Distributed (billions)|
But, by paying less out in dividends, the Fund has a larger balance from which to earn a return. Those higher returns result in a larger PFD calculation.
By my count, the Fund has earned about $390 million more than it would have by paying the “full PFD” for the last 3 years. As a result, the FY19 PFD calculation would have been only $2,891 if those reductions didn’t occur.
Which means that $58 of the 2019 PFD calculation is coming from not following the formula for the last 3 years – and keeping that money in the ERA.
Additional Royalty Deposits
Next, let’s pull out those historic royalty deposits that exceeded the 25% required by the constitution.
To do so, I used the historic royalty payments to the General Fund and the Permanent Fund, then reallocated the totals to match the 25% requirement.
The result is approximately $2.4 billion of additional royalties deposited over the last 40 years.
Without those additional royalty deposits, the Permanent Fund would hold about $5 billion less than it does today (the extra $2.6 billion coming from retained earnings on those deposits).
As a result, our upcoming PFD would work out to $2,657 each without those additional royalties.
Therefore, about $234 of the calculation is coming from those extra royalty deposits.
The idea of a Permanent Fund started following the Prudhoe Bay lease sale in 1969. In a single day, the State received a windfall of $900 million (the operating budget back then was only about $100 million). This left many people wondering what to do with so much money.
After years of debate and failed attempts, the Permanent Fund was finally establish in 1977. By then, that $900 million was long gone.
So, once the Alaska Permanent Fund Corporation was up and running, and oil revenues were flowing in, the legislature made a symbolic deposit into the fund. They appropriated $900 million to the Principal Account from the General Fund in 1981.
In 1982, the legislature approved another $1.8 billion of “surplus oil revenues” from the General Fund to the Principal Account – which was paid in installments over the next 4 years.
So, how would things look today without those initial deposits?
It turns out that compound interest is a marvelous thing. Without that $2.7 billion of fund capitalization nearly four decades ago, the Permanent Fund balance would be about $21 billion less than it is today.
As a result of the smaller balance, the earnings would also be smaller today. That means that our PFD calculation would be smaller too. In fact, a lot smaller.
It looks like the upcoming PFD calculation would work out to $1,733 each, if not for those initial funds and additional royalties.
This implies that $924 of the current PFD calculation is rooted in those initial deposits.
Each year, the Permanent Fund earns billions of dollars from investments. One-half of those earnings contribute to the PFD calculation. Of the rest, an amount needed to offset inflation on the Principal is supposed to be transferred.
The rest of the money is available for any public purpose (note: starting in 2018, the total amount used for PFDs and other public purposes cannot exceed 5.25% of the 5-year average value of the of the fund).
Traditionally, the legislature chose not to use those “excess earnings” to pay for government. Instead, they either transferred those funds to the Principal Account or left them sitting in the ERA.
But, what if those excess earnings were transferred to the General Fund (or Budget Reserve) rather than retained in the Permanent Fund.
By transferring that money to the General Fund throughout history, the Permanent Fund balance would be reduced another $13 billion. As a result, the earnings on the smaller balance bring the 2019 PFD calculation down to $1,341.
This implies that about $392 of the PFD calculation today is coming from the decision to retain excess earnings in the Permanent Fund rather than in another account.
Because inflation proofing is a transfer of money between accounts within the fund, it does not change the Fund balance or PFD calculation. It simply changes whether or not that money is accessible to the legislature.
However, to determine the impact of retained excess earnings above, we assumed that the inflation proofing rule was followed first (after paying the statutory PFD), and any remaining funds were transferred out of the Fund.
But, what if we didn’t have that inflation proofing rule?
This would means that all of the earnings from the fund were simply transferred to the General Fund each year (half of which would go to the PFD).
This would be the strict and minimal interpretation of the constitution, in which only 25% of royalties were saved and all income was distributed to the General Fund.
In this case, the balance of the Permanent Fund would be $15 billion today (plus about $3 billion of unrealized gains).
The realized earnings from the last 5 years would total only $5.6 billion, leading to a 2019 PFD of about $862 per Alaskan.
There’s been a lot of discussion about the “right” number for the PFD lately. However, it is worth knowing that the earnings that contribute to the current PFD formula don’t just come from the constitutionally required royalty deposits.
Most of the PFD calculation stems from decisions made by previous legislatures. Here is what is contributing to the PFD calculation for 2019:
Whether or not this is the way we want the PFD to be calculated is a question for the legislature (and the public) to consider.
If we are happy with it, that’s fine. But if it’s not achieving the desired result, we have a process for changing laws that aren’t working any more.