An Introduction to

Alaska Fiscal Facts and Choices

Gunnar Knapp
Director and Professor of Economics
Institute of Social and Economic Research
University of Alaska Anchorage
Gunnar.Knapp@uaa.alaska.edu

January 8, 2016

ISER publications and presentations are solely the work of individual authors and should be
attributed to them, not to ISER, the University of Alaska Anchorage, or the research sponsors.

Alaskas faces an extremely serious fiscal challenge.

We are spending more than twice as much as our revenues.
We are paying for the deficit by drawing down our savings.

We cant continue to run huge deficits like this years.

We dont have enough savings.

In the next few years,

we will have to close the funding gap
between our spending and our revenues.
We will have to make big changes
in what we spend or how we pay for itor both.

Alaska has been extremely dependent on

oil revenues to fund state government.

From 2005 to
2014, oil
revenues
averaged 90% of
Alaskas
unrestricted
general fund
revenues
(which pay for
state
government).

Our state revenues are extremely sensitive to oil prices

particularly at prices above $80/barrel.

Oil prices have fallen drastically over the past year and a half
and are continuing to fall.

The price was

$34/barrel on
January 5

Mostly because of the fall in oil prices, our oil revenues have fallen drastically.
Falling oil production and higher costs and credits have also played a role.

From 2005
to 2012 oil
prices and
revenues
rose
dramatically

$7.8 billion
drop in oil
revenues
from 2012
to 2016
(88% drop)

Historical

Projected

In just four years,

most of the money we had been
using to pay for state government
evaporated.
Its gone.
Thats why we have a big problem.

Wont oil prices go back up and save us?

It happened in the early 2000s when we faced a similar fiscal challenge.
It could happen again.
But it probably wont.
There is a glut of oil on world markets
Most oil market analysts think prices wont rebound above $70$90/barrel, because
So much oil production is profitable at those prices
Growth in world oil demand is slowing

Hoping that oil prices rise is not a realistic

or responsible solution to our fiscal challenge.
10

Even if oil prices rise, our oil revenues will decline

as oil production falls.

11

From 2005 to 2012, even though spending was rising,

we ran big General Fund surpluses. Since 2013 we
have been running big General Fund deficits.

Historical

Projected

12

We used the surpluses prior to 2012 to build up our savings reserve.

Since 2013 we have been rapidly drawing down our reserves.
Continued deficits of this years level could drain our reserves in 2 years.

Historical

Projected

13

This years (FY16) projected deficit is huge.

FY16 unrestricted
general fund spending
$7,100
per Alaskan

$5.2 billion

$3.6 billion
(69% of
spending)

$1.6 billion

Projected
deficit

Projected
revenues

$4,900
per Alaskan

$2,200
per Alaskan

Per Alaskan
figures are based
on 2014 Alaska
population estimate
of 735,601.

How we are spending $5.2 billion in FY16

641 (55%) is
Medicaid formula
1,247 (96%) is
K-12 formula

Trends in General Fund spending, FY07-FY16

16

The Permanent Fund is worth more than $50 billion.

Most of the value is in the principal, which we cant spend.
We can only spend the realized earnings in the earnings reserve,
which are currently about $7 billion.

17

The Permanent Fund earns billions of dollars in most years,

which go into the earnings reserve.

18

Every year, we take money out of the earnings reserve to pay for
dividends and inflation proofing.

19

In most recent years the Permanent Fund has earned more than we have used
for dividends and inflation proofingso we have been retaining some earnings
and the earnings reserve has been growing.

20

Like oil revenues, Permanent Fund earnings are highly variablebut they
have been growing as the Fund grows. For the past two years they have
been more than our oil revenues.

Historical

Projected

HOW WILL WE FILL THE FUNDING GAP?

Our only significant and practical options are some combination of:
Spending cuts
New revenues
Using Permanent Fund earnings

There are no easy choices.

The funding gap is so large that
we will probably need to use all of these options.

22

The challenge with spending cuts is figuring out what to cut that isnt
mandated, essential or penny-wise but pound-foolish.

Most cuts would have to come from state

agenciesincluding education & health

It would be
very difficult to
cut debt &
retirement
spending

Cutting oil tax

credits could
affect future
production
and revenues

Very little
capital
spending is
left to cut

There are many potential options for new state revenues

but none would be enough to close the funding gap.

Alaskans pay much lower broad-based state taxes

than residents of any other state.

Alaska

25

Using Permanent Fund earnings would require some combination of:

- Reducing Permanent Fund dividends
- Reducing inflation proofing
Adding less to the Earnings Reserve
Drawing down the Earnings Reserve

How would different options for closing the fiscal gap affect
Alaskas economy and Alaskans?
Option
Cutting
spending

Effect on the economy

Who would be most

affected

Fewer government jobs &

income

Government employees

Fewer contractor jobs &

income

Contractor employees

Multiplier effects of lower

spending by government
& contractor employees

Trade and service industry

businesses & employees
Beneficiaries of
government services that
are cut

How would different options for closing the fiscal gap affect
Alaskas economy and Alaskans?
Option
Income taxes
Sales taxes

Resource
industry taxes

Effect on the economy

Who would be most affected

Less personal income

Richer families (income taxes)

All families (sales taxes)

Multiplier effects of lower

spending by households

Trade and service industry

businesses & employees

Less business income

Fewer resource industry
jobs

Resource industry businesses

Resource industry families

Multiplier effects of lower

spending by resource
industry businesses &
households

Trade and service industry

businesses & employees

How would different options for closing the fiscal gap affect
Alaskas economy and Alaskans?
Option
Cutting
dividends

Effect on the economy

Less personal income

Who would be most

affected
All families
(The relative effects would be
greatest for poor families &
large families)

Multiplier effects of lower

spending by households

Trade and service industry

businesses & employees

How would different options for closing the fiscal gap affect
Alaskas economy and Alaskans?
Option
Cutting Permanent Fund
inflation proofing
Adding less to or drawing
down the Permanent Fund
earnings reserve

Effect on the
economy
No immediate effect
Slower Permanent
Fund growth
Lower future
Permanent Fund
earnings

Who would be
most affected
Future Alaskans

WHEN WILL WE FILL THE FUNDING GAP?

The more gradually we adjust,
the smaller the immediate direct effects on the economy.
But the longer we delay:
The bigger the future direct effects on the economy.
The greater the risk of forced drastic adjustments.
The greater the risk to investor confidence
The greater the risk to our credit rating
The lower our future investment earnings
The less savings we leave for future generations
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32

Four key choices that we face

in thinking about how to close the funding gap

Over any period of time what we can

spend is constrained by our income and
what we add to or take out of our savings.
Our income
- What we add to our savings
+ What we take out of our savings
= What we can spend

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Any choice that we make about anything affecting our

revenues, spending or what we add to or take out of our
savings affects our options for all our other choices.
Our income

- What we add
to our savings

Oil income
Permanent Fund earnings
Other current revenues
New tax revenues
Royalty deposits to the PF principal
Inflation proofing deposits to the PF principal
What we add to the PF earnings reserve
What we add to the CBRF

+ What we take What we take out of the PF earnings reserve

out of our
What we take out of the CBRF
savings
= What we can Government spending
spend
Dividend spending

1. What should we assume about

oil prices, oil production, and Permanent Fund rates of return?

Our income

Oil income
Permanent Fund earnings
Other current revenues
New tax revenues

- What we add Royalty deposits to the PF principal

to our savings Inflation proofing deposits to the PF principal
What we add to the PF earnings reserve
What we add to the CBRF

Oil prices & oil

production affect our
oil income.
Permanent Fund
rates of return affect
our Permanent Fund
earnings.

+ What we
What we take out of the PF earnings reserve
take out of our What we take out of the CBRF
savings
= What we
can spend

Government spending
Dividend spending

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2. How much do we want to tax ourselves or our industries?

Our
income

Oil income
Permanent Fund earnings
Other current revenues
New tax revenues

- What we
add to our
savings

Royalty deposits to the PF principal

Inflation proofing deposits to the PF principal
What we add to the PF earnings reserve
What we add to the CBRF

The more we raise from

new taxes the more we
can spend.

+ What we What we take out of the PF earnings reserve

take out of What we take out of the CBRF
our savings
= Our
spending

Government spending
Dividend spending

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3. How much do we wish to add to or take out of our savings?

Our
income

Oil income
Permanent Fund earnings
Other current revenues
New tax revenues

- What we
add to our
savings

Royalty deposits to the PF principal

Inflation proofing deposits to the PF principal
What we add to the PF earnings reserve
What we add to the CBRF

+ What we What we take out of the PF earnings reserve

take out of What we take out of the CBRF
our savings
= Our
spending

Government spending
Dividend spending

How much we add to or

take out of our savings
affects what how much
we can earn and spend
in the future.
The less we spend now,
the more we can spend
in the future
and vice versa.

37

4. How much do we want to spend on government and dividends?

Our
income

Oil income
Permanent Fund earnings
Other current revenues
New tax revenues

- What we
add to our
savings

Royalty deposits to the PF principal

Inflation proofing deposits to the PF principal
What we add to the PF earnings reserve
What we add to the CBRF

+ What we What we take out of the PF earnings reserve

take out of What we take out of the CBRF
our savings
= Our
spending

Government spending
Dividend spending

The more we spend for

dividends, the less we can
spend for government
and vice versa.

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Our options and choices for what we can spend

are fundamentally constrained by
our future oil revenues and permanent fund earnings.
They are also uncertain because we dont know what
oil prices and permanent fund rates of return.
The following graphs illustrate what the range
of what we could spend might be
for different combinations of assumptions.

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What our current oil and other revenues would be at different oil prices

What the Permanent Fund would earn at different rates of return

These projections assume that all earnings of the Permanent Fund are spent except those needed
to allow the fund to grow at the rate of inflation, so that its real value stays the same.

How much can we spend per year for government and dividends combined?
from our current revenue sources (oil revenues, non-oil revenues, and PF investment earnings)
without reducing the inflation adjusted value of the Permanent Fund over the next 10 years?

It depends on the price of oil and the Permanent Fund rate of return.

If we raise new revenues we could spend more.

If we want the Permanent Fund to grow
we have to raise new revenues or spend less.

How much can we spend per year for government?

from our current revenue sources (oil revenues, non-oil revenues, and PF investment earnings)
without reducing the inflation adjusted value of the Permanent Fund over the next 10 years?

It depends on the price of oil and the Permanent Fund rate of return
and on what we spend for dividends.
If we keep dividend spending at last years total ($1.4B) we could spend:

If we raise new revenues we could spend more.

If we spent less for dividends we could spend more.

Our fiscal options arent so bad compared with most other states.
Most other states:
Dont have any oil revenues
Dont have any Permanent Fund earnings
Thats why most other states:
Spend much less for government
Have income taxes and/or sales taxes
Dont pay dividends
Our basic fiscal options are to become more like other states:
Spend less for government
Tax ourselves more
Pay smaller dividends

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Two potential approaches to using Permanent Fund earnings

to fund state government

Approach

History/background

Senate Bill 114

Introduced during the 2015

legislative session

Walker administrations sovereign wealth

fund proposal

Proposal released by Walker

administration Fall 2015

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Major Alaska state revenues and spending flows, FY16

Non-Oil
Revenues

Constitutional
Budget
Reserve
Fund

Arrow sizes are

proportional
to FY16
revenue &
spending flows

Oil
taxes

Oil
royalties

General
Fund

Government
spending

Permanent Fund
realized earnings

Permanent
Fund
principal

Permanent
Fund
earnings
reserve

Dividend
spending

SB 114 approach: Swap funding for dividends and government

Non-Oil
Revenues

Constitutional
Budget
Reserve
Fund

Oil
taxes

Permanent Fund
realized earnings

Oil
royalties

General
Fund

Permanent
Fund
principal

Permanent
Fund
earnings
reserve

A payout would go from

Permanent Fund earnings to
the General Fund based on
5% of average market value
over the past 5 years.

Government
spending

Dividend
spending

Dividends would be paid

from 75% of oil royalties

Sovereign wealth fund approach: Almost all oil revenues would go to the
Permanent Fund, which would make a fixed payout to the General Fund.
Non-Oil
Revenues

Constitutional
Budget
Reserve
Fund

Oil
taxes

Permanent Fund
realized earnings

Oil
royalties

Permanent
Fund
General
Fund

Government
spending

A fixed annual payout would

go from the Permanent Fund
earnings reserve to the
General Fund
(estimated @ $3.2 B)

Dividend
spending

Dividends would be paid

from 50% of oil royalties