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A special task force on the state budget was charged by Commonwealth North directors to review and make recommendations as to how to address the State of Alaska’s immediate budget gap.
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Alaska’s Budget Crisis Kacing the Facts — Closing the Gaps
Commonwealth North Report December 1986
ALASKA'S BUDGET CRISIS: FACING THE FACTS-CLOSING THE GAP A Commonwealth North Report December 1986
935 West Third Avenue Anchorage, Alaska 99501
Technical support for this report was provided by Scott Goldsmith, Ph.d., Economics, Institute of Social & Economic Research, University of Alaska.
The conclusions of this report are those of Commonwealth North.
Commonwealth North
In July 1986, the Board of Directors of Commonwealth North established a Special Task Force on the State Budget.
The charge:
Budget Task Force Committee
Julius J. Brecht, Chairman
Smith, Gruening, Brecht, Evans
Admiral Jack Hayes Avis Car Rental Principal
Harold Heinze ARCO Alaska, Inc. President
Joseph Henri Southcentral Timber President
Roy M. Huhndorf Cook Inlet Region Inc. President
Connie Jones The Growth Company consultant
Millett Keller Millett Keller Co. Principal
Alaska Mutual Bank Sr. Vice President
Malcolm B. Roberts Malcolm B. Roberts and Associates
President
William Cc. Smart Partner In Charge
Frances E. Smith Office of Personnel Management
Area Manager
J. Shelby Stastny Arthur Young & Co. Partner & CPA
Connie Yoshimura Fortune Properties, Inc. President
Harza Engineering Alaska Regional Manager
Alaska's budget crisis
Alaska's economy runs on oil. Depending on the year, from 70% to 90% of the revenues to the state come from the Prudhoe Bay oil field. At this time a $1 drop in the price of oil means a $150 million drop in income to the State of Alaska.
When the price of oil soared in 1979, so did Alaska's economy, and so did state spending. Revenues to the state jumped from $764 million in 1978...to $1...$2...$3...$4 billion in 1982. Then the gradual drop began...from $4 billion in 1982...to $3.6...$3.3...$3.2...92.6 in 1986.
Yet, even as the drop began and Alaska's revenue forecast showed expectations for additional decline, the spending level increased. The difference was made up in one-time revenues and expectations of another rise in oil prices.
The FY 87 budget was passed at $2.5 billion...with oil at $19 per barrel. By June, oil prices had deteriorated to $10.09 per barrel - resulting in an estimated $800 million shortfall between actual anticipated revenues and appropriations.
Governor Bill Sheffield ordered a 15% cut in spending - equivalent to about $400 million - leaving the remaining cut for later.
The September revenue forecast of the Alaska Department of Revenue pegged oil prices at $12.65 per barrel. Anticipated revenue for the FY 87 is $1.4 billion. Anticipated revenue for FY 88 is $1.273 billion.
LEAVES THE STATE WITH A BUDGET IMBALANCE OF $1 BILLION.
@ THE STATE DOES NOT HAVE CURRENT REVENUE SOURCES, FROM PERMANENT FUND EARNINGS, NEW TAXES OR THE CORPUS OF THE PERMANENT FUND, TO MAINTAIN ITS CURRENT SPENDING LEVELS THROUGH THE 1990'S.
6 If IS LIKELY THE STATE WILL HAVE TO PRIMARILY RELY ON CURRENT REVENUE SOURCES FOR THE NEXT 10 TO 14 YEARS.
@ THE STATE DOES HAVE SUFFICIENT CURRENT REVENUE SOURCES TO ALLOW A GRADUAL REDUCTION IN SPENDING TO A SUSTAINABLE LEVEL.
@ THE STATE HAS THE CAPABILITY TO OVERCOME ITS CURRENT $1 BILLION SHORTFALL AND REACH A $1.4 BILLION TARGETED SPENDING LEVEL THROUGH A COMBINATION OF REDUCING SPENDING AND USING THE NON-DIVIDEND EARNINGS FROM THE PERMANENT FUND.
@ IF THE STATE DOES REACH A TARGETED SPENDING LEVEL OF $1.4 BILLION BY 1991, IT CAN SUSTAIN THAT SAME LEVEL OF PURCHASING POWER TO THE YEAR 2000 WITHOUT INCREASING TAXES OR ELIMINATING THE PERMANENT FUND DIVIDEND.
SOURCE:
The estimates in this report use the Department of Revenue 30% projections, September 86 Revenue Sources, Quarterly Update.
NOMINAL DOLLARS:
All dollar figures in this report are in nominal dollars, unless otherwise specified.
Basically, if inflation is 5% each year, a $1.4 billion budget today would be a $1.8 billion budget by FY 92...a $1.7 billion budget today would be a $2.3 billion budget by FY 92...and a $2.1 billion budget would be a $2.7 billion budget by FY 92.,
INFLATION:
This report assumes a 5% annual inflation factor, as do State projections. While forecasted inflation varies from 2.95% in 1987 to 5.58% in the year 2000, the longrange average is expected to be about 5% per year.
DIVIDEND OR PERSONAL INCOME TAXES?
For the purposes of this report, it is assumed that, in terms of actual revenue to the State, elimination of the dividend or the reimposition of personal income tax would yield about the same level of revenue. The decision as to which to do first will undoubtedly involve a number of decisions other than actual revenue produced.
USE OF THE PERMANENT FUND:
It is recognized that use of the inflation-proofing from the Permanent Fund may affect the future of the Fund.
The key to using the Permanent Fund earnings to sustain purchasing power of a $1.4 billion budget is discipline. In the early years, the Permanent Fund earnings will be more than is necessary to maintain purchasing power...but these monies will be needed later on as the gap grows between dwindling oil revenues and a budget of constant purchasing power.
Part I
Meeting the Short Term Budget Crisis
Solving the budget shortfall now with an eye to the future
The choice as to how to manage today's budget crisis depends on three considerations:
(1) How much "new" revenue is immediately available, or can be made available to make up the difference between falling revenues and current budget levels?
(2) How soon will new sources of long-term wealth be developed in Alaska to "rescue" the econony?
(3) Is the public satisfied with how public money is now being spent so they will agree to give up their Permanent Fund dividend or tax themselves to fund government?
Finding 1: The State cannot sustain a spending level of $2.5 billion into the 1990's on current income sources.
Under current Department of Revenue forecasts, a budget level of $2.5 billion could be sustained to 1989 before starting to invade the corpus of the Permanent Fund - and - only if, in the interim the State eliminated the Permanent Fund dividend and reimposed personal income taxes.
Finding 2: The State of Alaska does have revenues - in dividends from the Permanent Fund - and could have revenues - from reimposed income taxes or higher oil taxes - that would allow the Governor and the State Legislature to set a budget level over the next four years from $1.4 to $2.2 billion.
The decision as to which budget level to adopt will depend upon many factors, including:
(a) the price of oil;
(b) how soon Alaskans are willing to give up the Permanent Fund dividend or to accept a reimposed personal income tax to operate government} (c) the willingness of Alaskans to use the non-dividend earnings of the Permanent Fund to operate government.
Finding 1:
Finding 2:
Finding 3:
@ PUBLIC
Finding 1:
Finding 2:
Finding 3:
Alaska now faces the start of a permanent decline in revenue from existing fields in Prudhoe Bay.
Decline from existing fields in Prudhoe Bay will begin in 1989. North Slope production, on average, will only be one-half the current level in 1998.
The major sources of new revenue - those capable of replacing a significant portion of the Prudhoe Bay Revenue - are oil from the coastal plain of the Arctic National Wildlife Refuge and marketing of North Slope natural gas.
It may be 10 to 14 years before either North Slope natural gas or new oil reserves from ANWR "come on line".
Alaskans believe that state spending levels are too high.
Over 70% of the voters approved retention of the Constitutional spending limit in the November 3, 1986 election. The vote was directed toward the principle of a spending limit since it is widely known that the present amendment is inoperative.
Political public opinion polls taken in recent months indicate that Alaskans will not agree to give up their dividend or to tax themselves to prolong a government spending spree.
The Commonwealth North Budget Task Force Committee concludes that Alaskans want government spending "brought into line", but in a way that has the least disastrous effect on the economy.
($ Millions)
Total General Fund Percentage Derived Fiscal Year Unrestricted Revenues From Oil
Revenue sources FY 1986-89, Quarterly Update, September, 1986.
Alaska
Note:
Department of Revenue.
These projections are risk adjusted based on a 30% probability that revenues will not exceed these levels. They are expressed in nominal dollars.
Sources of Income from the Permanent Fund
($ Millions)
Income from the Permanent Fund
Fiscal Net Inflation
"Fiscal Projections", Alaska Permanent Fund Corporation, as of October 31, 1986.
What are the choices for meeting the budget shortfall?
(1) Maintain a Current Spending Level of $2.1 Billion
@ Immediately use all one-time nonrecurring revenues.
6 Immediately reimpose personal income taxes.
e@ Be prepared to begin using the corpus of the Permanent Fund within the next 3 years.
(2) Cut Back Spending Immediately to Match Revenue Forecasts of $1.2 Billion
e cut an additional $300 to $400 million from the FY 87 budget to wipe out the immediate shortfall between revenue and appropriations.
(3) ESTABLISH A SPENDING LEVEL THAT CAN BE SUSTAINED UNTIL NEW SOURCES OF REVENUE ARE DEVELOPED AND INITIATE A SPENDING REDUCTION PLAN TO REACH THAT LEVEL
@ Use revenue. forecasts to establish a spending level that can be sustained until the state develops additional sources of revenue.
WHAT ARE THE TRADEOFFS FOR VARIOUS BUDGET LEVELS?
To maintain purchasing power,/1 these events must occur at these years
Targeted Begin Using Begin Using Reimpose Begin Using Budget Goal Non-Dividend the Perman- Personal the corpus for 1991 Permanent ent Fund Income of the (billions §) Fund dividend Tax Permanent Earnings/2 to operate Fund government 1/ All dollar figures are in nominal dollars, as are projections from the State Department of Revenue, and reflect an assumption of 5% annual inflation. While State forecasts on "expectation for inflation" vary from 2.95% in 1987 to 5.58% in the year 2000, 5% is used in this model as an average in the long haul.
Non-dividend Permanent Fund earnings are the inflation proofing.as well as the reserves (also called undistributed income). In the Commonwealth North model, these earnings are only used in FY 87 and FY 88 to reach a targeted budget level of $1.4 billion in 1991. To continue to maintain purchasing power, the non-dividend earnings would have to be used again from 1991 on.
How long can various targeted budget levels be maintained...and what are the trade offs?
With no new substantial revenue sources expected within the next 10 to 14 years, the state will have to rely on existing revenue sources to meet its expenses.
How long can specified budget levels be maintained before the State:
e® must eliminate the Permanent Fund dividend?
@ or begin using the corpus of the Permanent Fund? The following are four scenarios that provide a framework for decision-making. In each case, the goal will be to step down to the targeted budget level by 1991. The question is how long the State can sustain the purchasing power of each target level.
I. A TARGETED BUDGET LEVEL OF $1.4 BILLION From FY 88 to FY 91 A budget target of $1.4 billion can be reached by combining annual budget reductions with non-dividend earnings* from the Permanent Fund.
From FY 91 to FY 00
The purchasing power of that §1.4 billion budget can be maintained through continued use of the non-dividend earnings of the Permanent Fund.
The purchasing power of a $1.4 billion budget can be sustained, if in addition to the above:
@ the Permanent Fund dividend is eliminated in FY 00;
@® personal income tax is reimposed in FY 02.
II. a Targeted Budget Level of $1.7 Billion
udget target of $1.7 billion can be reached and maintained
@ all one time revenues are placed in the General Fund, including the Budget Reserve Fund ($430 million);
@ the Permanent Fund dividend is eliminated in 1988,
The purchasing power of a $1.7 billion budget can be sustained if, in addition to the above:
The purchasing power of a budget level of $1.7 billion can be sustained, if in addition to the above:
@ beginning in FY 01 the corpus of the Permanent Fund is used for the operation of government.
TII. a Targeted Budget Level of $2.2 Billion
A budget target of $2.2 billion can be maintained if:
e all one time revenues are placed into the General Fund, including the Budget Reserve Fund ($430 million); e the Permanent Fund dividend is eliminated in 1988; e personal income tax is reinstated in 1991.
The purchasing power of a $2.2 billion budget can be maintained past 1994 only if, in addition to the above, the corpus of the Permanent Fund is used for the operation of government.
Iv. A TARGETED BUDGET LEVEL OF $2.6 BILLION
A budget target of $2.6 billion can be maintained if:
e all one time revenues are immediately placed in the Ceneral Fund, including the Budget Reserve Fund ($430 million); e the Permanent Fund dividend is eliminated in 1988;
What is the "best bet"?
(1) ESTABLISH A SPENDING REDUCTION PLAN WITH A TARGET OF A $1.4 BILLION BUDGET IN 1991.
@ The State of Alaska has the capability, with current revenue sources, to reach a target budget of $1.4 billion over the next four years without imposing new taxes or eliminating the Permanent Fund dividend.
@® The Governor should propose a Four Year Spending
Reduction Plan aimed at meeting the $1.4 billion target in 1991,
@ Annual reductions should be no less than $150 million per year, and depending on what formula is used, should average $200 million per year over the next four years.
@ The Spending Reduction Plan must be guaranteed, either through a formula in existing law, such as the Budget Reserve Fund, or in a newly proposed law.
(2) USE THE NON-DIVIDEND EARNINGS FROM THE PERMANENT FUND TO EASE THE TRANSITION FROM A $2.1 BILLION BUDGET TO A $1.4 BILLION BUDGET.
@ Use of the Undistributed Income account and Inflation Proofing will allow a transition from the $2.1 billion level to $1.4 billion without imposing taxes or giving up the dividend over the next four years.
(1) ESTABLISH A FLAT REDUCTION RATE OF $200 MILLION ANNUALLY.
The Advantages:
The Disadvantages:
(2) USE AN EXISTING FORUMULA AS THE MECHANISM TO ENFORCE SPENDING REDUCTION AND SPENDING REFORM.
Under the formula contained in the Budget Reserve Fund, up to 25% of the Fund can be used to bridge the gap between spending and income while at the same time, spending increases are limited to 5% of the preceding year's appropriations plus changes in population and inflation.
(a) It acts as a way of transferring funds, in measured amounts, to ease the transition from high spending levels to moderate spending levels as revenues fall.
(b) It limits the annual increases in spending allowed in any one year when revenues go up again.
The Disadvantages:
6 A series of legislative actions will be necessary to make the Budget Reserve Fund a workable tool to meet the immediate budget shortfall.
When the Fund was adopted last session, the intent was to use the next four years to build the Fund, so that as Prudhoe Bay production declined, the Fund would be large enough to ease the spending reduction over the following 10 years.
The fall in oil prices precipitated the $1 billion shortfall before the Fund had the opportunity to grow: sufficiently.!
As a result, the formula must be adjusted to meet immediate demands.
A Spending Reduction Plan Using the Budget Reserve Fund
How to move from a $2.1 billion to a $1.4 billion state budget in 4 years
THE FIRST GOAL IS TO MAKE UP THE $300 MILLTON SHORTFALL FOR
THE FY 87 BUDGET.
The Second Goal Is to Set a $1.8 Billion Budget Level for
@ The goal for FY 88 is $1.8 billion.
Fund.
withdrawals, would be $644 million.
The Budget Reserve Fund balance is currently $430 million.
The Legislature would increase the balance by appropriating the non-dividend earnings from the Permanent Fund FY 87...$420 million...to the Budget
Reserve Fund.
The Legislature would appropriate 25% of the Budget Reserve Fund...$215 million...to meet the current shortfall.
The Legislature would cut the remaining $75 million from the FY 87 budget.
The FY 87 budget appropriation, when the adjustments are made, will total $2.1 billion.
Revenues for FY 88 are forecast at $1.273 billion.
The shortfall from the FY 87 budget level is $800 million, which the legislature would meet by cutting $150 million from the FY 87 budget level and adding $650 million in revenues through the Budget Reserve
Balance in the Budget Reserve Fund, prior to any
The Legislature would increase the balance by appropriating non-dividend earnings from the Permanent Fund for FY 88...$657 million...for a total balance of
$1.3 billion.
25% of the Budget Reserve Fund...$325 million...would be insufficient to meet the shortfall.
The Legislature would amend the Budget Reserve Fund to allow a 50% withdrawal...$650 million...to meet the shortfall.
The Legislature would cut $150 million from the previous year's budget.
3. THE THIRD GOAL IS TO SET A $1.6 BILLION BUDGET FOR FY 89
Revenues for FY 89 are forecast at $1.262 billion.
The goal for FY 89 is $1.6 billion. The shortfall from the FY 88 budget level is $538 million, which the Legislature would meet by cutting $200 million from the FY 88 budget level and adding $329 million from the Budget Reserve Fund.
Balance in the Budget Reserve Fund, prior to any withdrawals, would be $650 million.
The Legislature would appropriate 50% of the Budget Reserve Fund...$329 million...to meet the shortfall.
The Legislature would cut $200 million for the FY 88 budget level.
4. THE FOURTH GOAL IS TO SET A $1.5 BILLION BUDGET FOR FY 90
Revenues for FY 90 are forecast at $1.352 billion.
The shortfall from the FY 89 budget level is $238 million which the Legislature would meet by cutting $74 million from the FY 89 budget level and adding $164 million from the Budget Reserve Fund.
Balance in the Budget Reserve Fund, prior to any withdrawals, would be $329 million.
The Legislature would appropriate 50% of the Budget Reserve Fund...$164 million...to meet the shortfall.
The Legislature would cut $74 million from the FY 89 budget level.
5. THE FIFTH GOAL IS TO SET A $1.4 BILLION BUDGET FOR FY 91
6 The Legislature would appropriate 50% of the Budget Reserve Fund...$82 million...to meet the shortfall.
THE 'BOTTOM LINE!
Will it be worthwhile to reduce spending to a $1.4 billion target level?
What will the State have to show by 1991 if it uses the Budget Reserve Fund combined with a Spending Reduction Plan to reach a $1.4 billion budget?
@ $82 million left in the Budget Reserve Fund e $250 million left in the reserve, or undistributed income account of the Permanent Fund earnings
The model developed by the Commonwealth North Budget Task Force uses only two years of non-dividend earnings from the Permanent Fund to supplement the Budget Reserve Fund between now and 1991.
Obviously, other combinations or choices of revenue are available.
The message is that the targeted budget level determines how much new revenue will be needed...and if annual reductions in spending are not made over the next four years, Alaska will have spent itself out of options for the 21st century.
Part II
Toward a New Direction in State Spending
THE CAPITAL BUDGET:
The State capital budget should never be less than $200 million, or the level required for federal matching funds.
ONE TIME REVENUES:
One time, nonrecurring revenues and windfalls should not be used directly for the operating budget because they inflate the budget to a level that cannot be sustained. Such revenues should be considered for the Budget Reserve Fund, the capital budget, or capital investment projects.
PERMANENT FUND EARNINGS:
Earnings from the Permanent Fund should never be considered part of the current unrestricted earnings of the State. They should always be treated as a special account, requiring annual appropriation by the Legislature.
PRIORITY FOR REVENUE SOURCES:
After spending reduction, if the need arises for additional revenue, a priority should be established that takes into account effect on the development of new revenues, effect on the general economy, and the maintainance of the Permanent Fund in perpetuity.
The following priority is recommended:
~ Dividends
Personal Income Tax
Sales Tax
Oil and Resources Industry Tax
Cap the Permanent Fund and divert the 25% royalties into the General Fund
Divert the corpus of the Permanent Fund into the General Fund
THE KEY TO SUCCESSFUL BUDGET REDUCTION: NO SACRED COWS
The goal is to provide top quality public service on a $ for $ basis.
All State programs should be reviewed in light of established criteria:
All blanket distribution programs, previously supportable because of high oil revenues, must be reviewed for phase-out, capping, or conversion to loan or need basis.
These programs include the Longevity Bonus and Power Cost Equalization.
Ideas for cutting back the budget
The following ideas are included from the dozens that were discussed during the review of the Budget Task Force, because each began to show up repeatedly from other groups concerned with the budget, including state employee groups.
@ Change the work week back from 37 1/2 hours to 40 hours.
Discontinue COLA (Cost of Living Allowances). Eliminate regional pay differentials.
Bring salaries in line with actual responsibility and productivity.
Modernize the classification system.
Reassess position upgrades.
Reduce salaries.
Conform leave and state holidays to national norms. Conform retirement packages to national norms.
@ Prioritize programs according to the mandate of each department.
@ Eliminate funding for programs or groups that, as a matter of practice, sue the State of Alaska.
@ Eliminate funding for non-profit groups funded by direct legislative action that are performing services already being performed by other agencies or groups or go to competitive bidding for these services.
Into the Future - Changing the Direction of State Spending
Using the budget crisis as an opportunity.
I. THE STATE OF ALASKA SHOULD USE THE NEXT FOUR YEARS TO STREAMLINE STATE SPENDING.
II. THE STATE OF ALASKA SHOULD SUBSTANTIALLY SHIFT THE FOCUS OF STATE SPENDING FROM THAT OF SUPPORTING MORE GOVERNMENT TO THAT OF BOOSTING THE GROWTH AND DIVERSITY OF THE PRIVATE SECTOR.
The goal should be to move government from being a provider of public services to that of acting as a facilitator, on behalf of the public, for quality service by the private sector.
THE STATE SHOULD RESTORE CREDIBILITY TO CAPITAL SPENDING BY FOCUSING ON NEED, EFFICIENCY, AND GIVING PRIORITY To PROJECTS THAT ARE REVENUE-PRODUCING.
The practice by individual legislators of viewing unspent revenues as "their" money, even if other projects have greater merit, must stop.
@ The capital spending program should be focused on revenue~producing projects that will help revitalize Alaska's economy.
New Spending Goals...new Decisions
Spending reform is just part of the solution to a vital Alaska future.
A STRONG ECONOMY IS JUST AS CRITICAL TO ALASKA'S FUTURE AS SPENDING REFORM.
THE STATE MUST TAKE AN AGGRESSIVE, COMPETITIVE POSTURE TO ENCOURAGE THE DEVELOPMENT OF NEW WEALTH.
(a) The State of Alaska must actively compete for world market share of resource sales by encouraging responsible development of its own resources.
(b) The State of Alaska must place a priority on the development of the two known sources of new revenue most likely to determine the future health of the economy:
(c) The State of Alaska must take an active role in encouraging all levels of economic activity so new wealth can be generated as Prudhoe Bay wealth declines.
SPENDING PRIORITIES SHOULD BE DIRECTED TOWARD THOSE ACTIVITIES, SERVICES, AND PROGRAMS THAT WILL ASSIST IN THE GENERATION OF NEW WEALTH FOR ALASKA.
Commonwealth North is a non-profit corporation, organized and existing under the laws of the State of Alaska.
As well as providing a forum for national and internationally known speakers, working committees study critical issues facing the state and prepare action papers, such as this one.
Commonwealth North was founded in 1979 and co-chaired by two former Alaska Governors, Governor Wa William A. Egan. ‘The two sat as co=
Egan's death in 1984,
Governor Walter J. Hickel Chairman
Richard F. Barnes Vice President
Harold Cc. Heinze Vice President
Paul Wilcox Treasurer
Julius J. Brecht
Archbishop Francis fT, Hurley Suzanne Linford
The Honorable Ralph E. Moody Malcolm B. Roberts
Frank G. Turpin
liter J. Hickel and Governor chairmen until Governor
Bertram B. Beneville President
David L. Chatfield Vice President
Robert FE. Bulmer Secretary
Carl F. Brady
Millett Keller
The Honorable Tony Knowles Jeff Lowenfels
George N. Nelson
William J. Tobin
Connie Yoshimura
Judith M. Brady Executive Director
A Report By
COMMONWEALTH NORTH 935 West Third Avenue Anchorage, Alaska 99501 (907) 276-1414
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