Alaskanomics: "Risk and Reward" The Permanent Fund as a Source of Income for Alaska"

By Tim Bradner
[Original Source]

It seems inevitable that state of Alaska finances will soon be closely linked to performance of the state’s Permanent Fund. That has caused many Alaskans to look closely at how this change could affect the Fund’s management, and at the institutional protections for the Fund built into state law. Some consider those protections weak.

Gov. Bill Walker has proposed legislation that would make earnings of the Fund available to help support the state budget, and also put limits, indirectly, on the popular Permanent Fund Dividend.

The governor’s plan, in Senate Bill 128, passed the state Senate but not the state House, mainly over concerns about limiting the dividend in an election year. The governor is still pushing for passage of the bill either in a possible special session later this year or the regular 2017 session that begins in January, and with the 2016 elections over it’s quite likely the bill will pass.

Basically, Walker’s idea, which was modified in the state Senate, provides for an annual payment of the Fund’s earnings equal to 5.25 percent of the market value of the Fund, a “payment of market value”, or POMV, that is used by many large endowments in one form or another.

Based on this, the Fund could contribute between $2 billion to $2.5 billion yearly in support of the state general fund budget and still leave enough income retained in the Fund to offset inflation, and to allow the Fund to continue growing.

Of course, this would still leave a large deficit in state finances which would have to be filled with other revenues, most likely taxes in some form.

Here’s the math: If the state general fund budget is $4.5 billion, approximately its current level, and oil revenues contribute $1.2 billion, again about the current amount (and assuming, conservatively, that oil prices will remain in current range for an extended period), and that non-oil taxes contribute $300 million, this leaves a deficit of about $3 billion.

This is close to the state’s actual deficits for the past two fiscal years, which are being paid for by drawdowns from the Constitutional Budget Reserve, another state savings account (this fund will be exhausted in two years).

If the Permanent Fund can provide $2 billion to $2.5 billion each year, that still leaves a gap of $500 million to $1 billion to fill. The governor’s solution to this is a mixture of tax increases on various industries like fisheries and mining as well as a hike in the state’s motor fuel tax, which is the lowest in the nation, and a broad-based tax like a personal income tax.

However, given that some kind of change to the Permanent Fund’s relation to the state budget is coming, what questions does this raise?

First off, there are many who are concerned that a 5.25 percent annual draw is too high, that it could erode the Fund over time. Given the long-term uncertainties for financial markets, which are driven by expectations of long-term lower growth in the world economy, many pension funds and endowments are lowering their percentages of annual draws to four percent or 4.5 percent.

If the state of Alaska decides to be more prudent, that would lower the amount the Fund would make available to help the budget, requiring an increase in revenue from other sources or additional spending cuts.

The Permanent Fund’s managers say there are ways a larger draw can be accomplished, however, because the Fund is actively managed and that changes in asset allocations can result in more income. However, more aggressive management of the Fund will also assume more risk, an important consideration.

There are other issues affecting management, for example how the requirement to meet a required large annual cash payout would affect the Fund managers’ decisions over a mix of short-term, more liquid (and less income-producing) investments compared with that are long-term and less liquid (and more income-producing). These are issues but they are similar to those faced by other large endowments and can be dealt with. To some extent the Fund faces this problem now on a smaller scale, in ensuring that $1.5 billion or so is available in the fall to finance the annual PFD payout and an annual “inflation-proofing” payment of earnings back into the Fund to further offset inflation, although this has been low in recent years.

If the state does begin to use Permanent Fund earnings to help support the state budget, the governor and the Legislature will have to balance different goals. One, most important, is preserving and growing the Fund over the long term. A second, if the Legislature approves the governor’s plan, will be to have the Fund become a reliable source of revenue.

A concern many Alaskans have is that these two goals could conflict with each other.