1 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 [email protected]January 7, 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.
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1
An Introduction toAlaska Fiscal Facts and Choices
Gunnar KnappDirector and Professor of Economics
Institute of Social and Economic ResearchUniversity of Alaska [email protected]
January 7, 2016
ISER publications and presentations are solely the work of individual authors and should beattributed to them, not to ISER, the University of Alaska Anchorage, or the research sponsors.
Alaska faces an extremely serious fiscal challenge.
My goal in this presentation is tohelp Alaskans understand the basic facts ofthis state finances and the choices we face.
I am not advocating for any particular choices.
2
Alaska’s 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.
3
We can’t continue to run huge deficits like this year’s.We don’t have enough savings.
4
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 changesin what we spend or how we pay for it—or both.
5
Outline
• Alaska fiscal facts– State revenues– State spending– The Permanent Fund
• Alaska fiscal choices– How to close the funding gap?– When to close the funding gap?
6
Alaska fiscal facts:
State revenuesState spending
The Permanent Fund
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What most states’ revenues and spending flows look like
GeneralFund
Unrestricted General Fund
spending
SavingsFund
Non-OilRevenues
Federalrevenues
Spendingfor federallymandated
uses
DesignatedGeneral Fund
revenues
Spending for designated
uses of revenue sources
Major Alaska state revenues and spending flows, FY16
GeneralFund
Oilroyalties
Governmentspending
Permanent Fundrealized earnings
ConstitutionalBudgetReserve
Fund
PermanentFund
principal
PermanentFund
earningsreserve
Non-OilRevenues
Oiltaxes
Dividendspending
Arrow sizes are proportional
to FY16 revenue &
spending flows
From 2005 to 2014, oil revenues
averaged 90% ofAlaska’s
“unrestricted general fund
revenues”(which pay for
state government).
Alaska has been extremely dependent onoil revenues to fund state government.
10
11
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.
12
The price was $36/barrel on December 11
ProjectedHistorical
$7.8 billion drop in oil revenues from 2012
to 2016(88% drop)
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.
13
From 2005 to 2012 oil prices and revenues
rose dramatically
In just four years,most of the money we had been
using to pay for state governmentevaporated.
It’s gone.
That’s why we have a big problem.
Won’t oil prices go back up and save us?
• It happened before—in the early 2000s—when we faced a similar fiscal challenge.
• It could happen again. But it probably won’t.– There is a glut of oil on world markets– Most oil market analysts think prices won’t rebound above $70-
$90/barrel, because• So much oil production is profitable at those prices• Growth in world oil demand is slowing
• Even if oil prices rise, our revenues will fall as oil production falls.
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Hoping that oil prices rise is not a realisticor responsible solution to our fiscal challenge.
At $70-$90/barrel, how much total revenue would we get?
$3.3 billion @ $90/barrel
$2.2 billion @ $70/barrel
We are spending $5.2 billion this year.
Even if oil prices rise, our oil revenues will decline as production falls.
17
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.
ProjectedHistorical 18
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 year’s level could drain our reserves in 2 years.
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ProjectedHistorical
This year’s (FY16) projected deficit is huge.
FY16 unrestricted general fund spending
$5.2 billion
$3.6 billion(69% of
spending)
$1.6 billion
Projected deficit
Projected revenues
$7,100per Alaskan
$4,900per Alaskan
$2,200per Alaskan “Per Alaskan”
figures are based on 2014 Alaska
population estimate of 735,601.
How we are spending $5.2 billion in FY16
1,247 (96%) isK-12 formula
641 (55%) isMedicaid formula
Trends in General Fund spending, FY07-FY16
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The most unusual, complicated and least understood part of state financesis the Permanent Fund and the Dividend Program.
GeneralFund
Oilroyalties
Governmentspending
Permanent Fundrealized earnings
ConstitutionalBudgetReserve
Fund
PermanentFund
principal
PermanentFund
earningsreserve
Non-OilRevenues
Oiltaxes
Dividendspending
Constitutionally mandated contributions from
oil royalties toPermanent Fund principal
about 30.5% of oil royaltiesabout $0.9 B in FY16
Inflationproofing
about $0.9 Bin FY16
PermanentFund
Principal$47.3 B
May notbe spent
Permanent Fund realized earningsabout $2.7 B in FY16
PermanentFund
earningsReserve$7.6 B
May be spent
Dividend spendingabout $1.4 B in FY16
Formula: about half of realized earnings over the past 5 years
The Permanent Fund is worth more than $50 billion. We can only spend the “realized earnings” in the earnings reserve, which are
currently about $7 billion.
25
The Permanent Fund has been earning billions of dollars in most recent years. We have been putting that money in the earnings reserve—and then drawing
money back out to pay for dividends and inflation proofing.
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We have been using Permanent Fund earnings to pay for dividends and inflation proofing.
27
In most recent years the Permanent Fund has earned more than we have used for dividends and inflation proofing—so we have been retaining some earnings
and the earnings reserve has been growing.
28
Like oil revenues, Permanent Fund earnings are highly variable—but they have been growing as the Fund grows. For the past two years they have
been more than our oil revenues.
ProjectedHistorical
Alaska’s fiscal choices
How will we fill the funding gap?When will we fill the funding gap?
30
HOW WILL WE FILL THE FUNDING GAP?
Our only significant and practical options are some combination of:
Spending cuts
New revenues
Using Permanent Fund earningsby some combination of:
- Reducing Permanent Fund dividends- Reducing inflation proofing
- Adding less to the Earnings Reserve- Drawing down the Earnings Reserve
There are no easy choices.
The funding gap is so large thatwe may need to use all of these options. 31
The challenge with spending cuts is figuring out what to cut that isn’t mandated, essential or “penny-wise but pound-foolish.”
Very little capital
spending is left to cut
It would be very difficult to
cut debt & retirement spending
Cutting oil tax credits could affect future production
and revenues
Most cuts would have to come from state agencies—including education & health
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 taxesthan residents of any other state.
Alaska 34
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
The Permanent Fund can earn us billions of dollars each year.But the earnings will vary widely depending on the rate of return we earn
and how large we grow the fund.
Rates of return1996 – 2015
(omits -6.8% return in 2009)
Estimatedstart-of-FY17
value
APFC projections for start-of-FY26 value with status quo management
APFC projectionsassume average 4.88%
statutory return
Three potential approaches to using Permanent Fund earningsto fund state government
Approach History/background
Legislature appropriates funds from the earnings reserve, with or without changes in dividends and inflation proofing
The legislature can do this by a simple majority vote
Senate Bill 114 Introduced during the 2015 legislative session