The Alaska State Legislature recently passed SB 26, also known as the “Permanent Fund Protection Act”. The Governor is sure to sign the bill into law, seeing as he introduced it. So, what exactly does this bill do and why was it necessary?
Let’s explore some of the claims.
The Permanent Fund holds nearly $65 billion of past oil revenues for future generations
The Permanent Fund does hold nearly $65 billion, but only about $16.5 billion are deposits from oil revenues. The rest of the money comes from fund earnings that still sit in various accounts of the fund.
The constitutionally protected account (the principle account) holds all the oil deposits, plus about $16 billion of deposits to offset inflation, and another $7 billion of money that the legislature decided to reinvest (money they could have spent on general fund purchases if they wanted too). That adds up to just under $40 billion which the legislature cannot touch.
Another $7 billion sits in an account called “unrealized earnings”, which is mostly appreciation on real estate. Once the property is sold, those gains move to the earnings reserve.
The earnings reserve account (ERA) is where all the “realized” fund earnings land. Those earnings are eligible for general fund appropriation by the constitution. This account is also where our dividends come from.
While it historically was an escrow account for dividend payments and everything else was appropriated back to the principle, it has now become a savings account. The current balance is over $17 billion, which the legislature can use however it sees fit.
Until the legislature passed SB 26, the Permanent Fund was at risk
The principle account of the Permanent Fund is constitutionally protected. The legislature cannot spend that money. Not even with a statute that says they can. Those funds were not at risk and remain protected.
But the Dividend is at risk of going away without some form of protection
I’ll call this “based on a true story”
The Dividend is a portion of the income the Permanent Fund Corporation earns by managing the fund. The current statute sets the Dividend at one half the earnings, but basically uses a 5-year moving average to reduce the amount of swings we might see.
It is true that if the legislature decides to spend the earnings on government, then there won’t be any money to pay the dividend. But there are several ways to ensure the dividend payments are made. One way is to reduce government spending (cut the budget). Another is to increase government revenues (impose a tax).
But SB 26 doesn’t protect the Dividend. It just creates a spending limit on the earnings to discourage using so much that the dividend couldn’t be paid.
This bill allows the government to spend our dividend on bigger government
Article 9, Section 15 of the constitution states “All income from the permanent fund shall be deposited in the general fund unless otherwise provided by law”. So, the legislature didn’t really need to pass this bill in order to spend the other half of the money that the Fund earns.
What the bill does do is limit the draw on the ERA to a percent of market value (POMV). The bill does not change the dividend calculation at all. It remains the purview of the legislature to decide how much money to distribute as dividends.
If there isn’t enough money to cover the deficit and also pay the dividend with the POMV draw they will just draw more money or will cut the dividend
The Supreme Court found that State statutes regarding appropriations are merely guidelines. Even if the statute is strongly worded, like “must automatically transfer”, the legislature doesn’t need follow that law. So, Senator Wielochowski is right, it’s “just a piece of paper”.
While the bill sets guidance for limiting the draw from the earnings reserve, future legislatures can exceed that limit.
This year will be the first time the legislature spends money out of the earning reserve on government
In all previous years, either State revenues were sufficient to fund the budget or there was enough money in the other savings accounts to pay the bills. So, even though the legislature always had the authority to transfer money to the general fund, they elected to reinvest the money into the principle account instead.
Several years ago, the practice of transferring the money to the principle account stopped and the money stayed in the earnings reserve. This is why the earnings reserve account has so much extra money in it now (plus the money that was supposed to be distributed as dividends over the last few years).
If the legislature follows the rules this bill created, the dividend will be cut
Brad Keithley recently wrote a good article about this. If they really do limit themselves to 5% of the fund balance as the draw, it is likely that there won’t be enough money to cover the deficit and pay the full dividend in most years.
This will leave the legislature with 3 options: don’t follow the POMV law, don’t follow the dividend law, or raise the difference in taxes. If you take away the extra draw option, cutting the dividend is more likely to happen than passing a tax.
The earnings reserve will be empty in 3 or 4 years.
The earnings reserve receives cash inflow each year. It is where all the “realized earnings” go. If the fund earns 7% interest, they move 2% to cover inflation, and take 5% of the fund value out of the earnings reserve, the earnings reserve balance doesn’t change (there’s a technicality here, but the point stands).
So, aside from the potential of a few really bad investment years in a row or gross overspending by the legislature (contrary to the new law), the earnings reserve won’t ever run out. And even if it does, there will be more earnings deposited the next year.
In 2009, the fund lost nearly 18% of its value. One year like that and the whole earnings reserve is gone
This belief comes from the fact that the earnings reserve has a current balance of roughly $17.6 billion in assets. The total fund balance is about $64.6 billion. So, if they lost 18% of the fund value, it would be a reduction of just over $11.6 billion. Take another 5% draw to the general fund to pay for government and dividend (about $3 billion) and the earnings reserve is down to $3 billion, before any inflation proofing.
However, this isn’t quite right. In 2009, the fund lost $6.4 billion in value. However, the earnings reserve only decreased by $2.5 billion. The reason is that a lot of the losses happened as a result of decreased property value.
This argument is kind of like saying “if my house lost $10,000 in value, my savings account would be empty”. That just doesn’t make any sense at all. The only way your savings account would be impacted is if you tried to sell your house for a loss. That’s why there is this whole other account called “unrealized earnings”.
The earnings reserve is actually very healthy, so long as they don’t draw too much. This lack of appreciation for the shielding effect of unrealized earnings is one of the reasons I question the Corporation’s projections.
This bill is a monumental shift in Alaska’s financial policy
The reality is, if the legislature had been following the laws up to this point, this bill would quite literally do nothing at all. Let me explain.
The current framework is this: the constitution says “All income from the permanent fund shall be deposited in the general fund unless otherwise provided by law”. There are two applicable laws. One is the dividend which basically reserves half the earnings to be given directly to the people. The other is “inflation proofing” which just says you should transfer some of the earnings back to the principle account so that it doesn’t get devalued over time. Everything else goes to the general fund.
So, according to existing law, if you had a zero starting balance in the earnings reserve today and the fund earned $4 billion on investments over the year. With simplified numbers, you would give $2 billion to the dividend, call it $1 billion for inflation proofing, and would transfer $1 billion to the general fund. How does that change under SB 26? It doesn’t.
What if that $1 billion didn’t cover the deficit? Under existing law, they would have to either take money from inflation proofing or the dividend to cover it. And under SB 26? Exactly the same.
In fact, the only reason that SB 26 does anything at all is because previous legislatures didn’t follow the statutes. They didn’t pay the full dividend, didn’t inflation proof, and didn’t transfer the remaining funds to the general fund. Now the earnings reserve has all that extra money in it as a result. So, this new law just gives guidance on how fast they should spend that money they didn’t spend before.
This bill will kill the dividend program
This bill doesn’t do a single thing to the dividend. Doesn’t protect it, doesn’t put it on the path to its end, doesn’t change a thing. The dividend was at risk before this bill, and remains at risk with it.
Nothing the current legislature can do will protect it from future legislators’ decisions.
We need to repeal this bill
I’m not in love with this bill, but I don’t hate it. There are some good guidelines here, if they follow them.
Repealing the bill wouldn’t change anything at all. The legislature can still decide how much to pay in dividends and how much to spend on government, even if this bill is repealed.
The only way to really protect the dividend is with a constitutional amendment
Heard any other stories about this bill? Leave me a comment and I’ll update this page.