FOR ALASKA

BREAKING THE FALL: BuDGET RECOMMENDATIONS FOR ALASKA

Declining oil production and low oil prices are bringing Alaska’s state government closer to the financial cliff—but we can still save ourselves from falling over the edge.

The state currently faces a $1 billion budget deficit and will face future deficits, because oil revenues—which pay 85 percent of government costs—are declining.

Commonwealth North (CWN) proposes budget actions the state should take immediately, and others it should take over the next four years.

CWN recognizes that some of these actions are politically unpopular and will be strongly resisted. But if we don’t begin now, there will soon be a steep fiscal drop that will require far more draconian remedies.

These recommendations grew out of CWN’s October 1993 budget conference and subsequent work by a CWN budget committee. All the tools for closing the state's "fiscal gap", as identified by Scott Goldsmith of the University of Alaska Anchorage's Institute of Social and Economic Research, are utilized in these recommendations.

Commonwealth North

March 1994

Fiscal Implications

Cut Spending

• Freeze the operating budget below current levels.
• Reduce the capital budget to below historic levels.
• Cap Permanent Fund Dividend expenditures at current levels.

$60 million reduction in FY 95.

A $100 million budget is $150 million below historic levels and $516 million below FY 94.

Save at least $34 million in FY 95.

Increase Revenues

• Increase taxes and user fees. Consider increasing “sin,” motor fuel and fish taxes.
• Change the statutory priority to inflation-proof Permanent Fund first.
• Encourage increased oil exploration and development.

Up to $90 million in new revenues annually. Could add $850 million more to principal by 2005, depending on use of Earnings Reserve.

100,000 bbi/day increase in production yields $50-100 million/year.

Get A Plan

• Create Alaska Finance Commission with administrative, legislative and public members to produce a four-year financial plan.
• Develop a plan for saving, consolidating and providing prudent access to reserves and nonrecurring future revenues.
• Create income tax commission including legislative, administrative, and public members to hold hearings, analyze tax structures and submit a tax proposal to the legislature in Jan. 1995.

Year-to-year predictability and stability of revenues and expenditures.

Existing and future reserves ($1-$3 billion) protected from short-term liquidation. Total reserves available would be predictable.

Revenues ($250-400 million) from an income tax will take a minimum of two years from enactment to fully realize.

Reduce State Spending

In recent years state spending has far exceeded normal recurring revenues. The State has used windfalls, tax settlements, and reserves to fill the gap.

Alaska must cut spending before taking any other steps to balance the budget. The State can significantly reduce spending over time by holding the budget at current levels and absorbing inflation and population growth. Such action would allow the state to maintain basic services and avoid serious disruption of Alaska’s economy, which relies heavily on state spending. Officials would be forced to set spending priorities, increase efficiency, and make cuts.

Alaska must immediately draw up a long-term financial plan. Successive administrations and legislatures have simply budgeted from year to year, depleting a large share of reserves, making state spending volatile, and risking Alaska’s long-term financial health.

Save RESERVES

Despite the State’s lack of discipline in spending reserves in recent years, considerable reserves remain— including more than $800 million in the Constitutional Budget Reserve Fund (CBR), $1.1 billion in the Earnings Reserve Account (ERA) of the Permanent Fund and perhaps $1 to $3 billion in outstanding legal disputes.

We assume that the State will spend as much as $800 million of existing reserves this year to meet unexpectedly large deficits for fiscal years 1994 and 1995. We also assume that the legislature will address the nearly $1 billion court-ordered deposit to the CBR. Still, as much as $1.2 billion in reserves will remain—cither in the CBR or in the ERA. But, projected deficits for the next two to three years could equal most of these remaining reserves.

Neither the CBR nor the ERA appears adequately protected from easy, short-term access or, on the other hand, structured to allow realistic flexibility to meet unforeseen future circumstances. We must determine a better way to consolidate and husband the reserves we still have and those we expect to get in the future. Any restrictions on these funds that would bind future legislatures would require a constitutional amendment.

Protect the Permanent Fund

The legislature can’t spend the principal of the Permanent Fund, but it can appropriate the earnings. About half is used to pay dividends to Alaskans. Paying dividends takes precedence over any other use of earnings.

Earnings should go toward inflation-proofing the Fund first. In the future under current law paying dividends will use so much of the earnings that there won’t be enough left to fully inflation-proof the Fund, and there will be no earnings available to help pay for general government.

The amount that goes toward paying dividends should first be capped and then reduced $50 million per year over the next several years. The dividend program could continue, although dividends would be smaller. Remaining earnings would stay in the earnings reserve and be available to help pay for general government.

BROADEN Tax Base

Increasing some existing taxes and user fees—like alcohol, tobacco, motor fuel and fish taxes—could fill a small part of the gap and help pay for state services.

Alaska will need an income tax in the near future. It could raise an estimated $250-400 million annually, it is progressive, it is deductible against federal taxes and it taxes wages of non-resident workers. It could also help capture and pay for benefits of development, without impeding the competitiveness of the development.

The State should immediately create atax commission to determine by January, 1995, how best to structure an income tax. It would take at least two years after enactment for full tax revenues to flow into the state treasury.

Promote Economic DEVELOPMENT

The lion’s share of state revenues in the foreseeable future will—despite the overall decline in production— still be from oil development. Development of new, smaller oil fields is possible and should be encouraged.

The State should continue to promote development of a gasline to carry natural gas from the North Slope, the lifting of the ban on the export of North Slope oil, and the opening of the Arctic National Wildlife Refuge to oil development. But we can’t count on those developments for future state revenues.

The State should provide a positive climate for development. Resource developments other than oil would provide relatively little state revenue under the current tax system. But new developments can benefit local governments through property and other local taxes— which could help offset reduced state aid to local governments. Also, a state income tax could capture the benefits of new economic development and jobs by taxing increased personal income.

• Hold future -budgets below inflation and population growth. Reductions achieved by:
• Limiting growth of formula/entitlement programs 4

_ -- Phasing out unique: programs not based ‘on need...

“©. Restructuring programs for'efficiencies, privatiza-- tion opportunities, possible local government respon- _ sibility and wage, benefit savings.

• Reduce, but not eliminate, total Permanent Fund Dividend expenditures over time.
• Reimpose. a:personal income tax.
• Establish a consolidated account for existing reserves and future non-recurring revenues with restrictive access provisions, including super majority vote and maximum annual withdrawal.
• Emphasize equities in Permanent Fund investments.
• Re-evaluate the inflation-proofing mechanism and dividend program to reflect Permanent Fund unrealized capital gains, earnings and asset allocations.
• Provide a positive economic’ and regulatory ~ climate for future developments.
• Continue to promote the marketing of North Slope natural gas, the opening of Alaska National Wildlife Refuge and lifting of the oil export ban.

Fiscal Implications

Up to 5% annual reduction in inflation-adjusted ‘dollars: Reduces state spending by $100-120 million annually, or a cumulative budget cut of nearly $500 million vy 1998.

Reducing expenditures by $50 million/year would save $278 million in FY 98. Would permit individual dividends of approximately $675 in FY 98.

: Could r raise $250- 400 million i in revenues annually.

Existing and future reserves s ($123 billion) would be protected from short-term liquidation. Total reserves available would be known and predictable and could be used as needed over many years.

Equities have outperformed other investments over _ time and have earned returns well in excess of “inflation. A 1% increase in. the Fund’s earnings equals $186 million in FY 2000.

Currently unrealized gains are not calculated in the Fund’s value. The decision to take capital gains may be affected by potential impacts on annual earnings, inflation-proofing and dividends. Some inflation-proofing is occurring through equity investment.

: Diversified development would buildan employment base to Felpe offset # declining oil revenues.

A gasline could contribute $250- 450 million annually, ANWR development $0.8-$2.5 billion annually and the export ban repeal $150-200 million.

Millions of Dollars

Fiscal Implications of CWN Recommendations

Budget Cuts 2000 PED* Reserves 2000 Reserves (In CBR or ERA*). 4

Forecasted Recurring GF* Revenues 1500 Recurring GF* Revenues 1500

At Current Oil Prices

FY1994 1995 1996 1997 1998

Notes: 1. Maintenance level budget (operating budget 3% growth, $300 mil. capital) CBR: Constitutional Budget Reserve Fund 2. CWN recommended total spending cap ($2.46 billion) ERA: Permanent Fund Earnings Reserve 3. Income tax comes in 1/2 year in 1997, full year 1998: Account 4. PED reductions from status quo; increase $ in ERA available for appropriation PFD: Permanent Fund Dividends 5. Existing reserves remaining in FY98 - about $500 million GF: Unrestricted State General Funds 6. Dept. of Revenue forecast: FY94, Actuals; FY95, 2/94 forecast; FY96-98, Fall '93 low-case ($15-17/bb1.) 7. Estimated revenues at current oil prices($13.25/bbl.)

Commonwealth North

Commonwealth North is a non-profit corporation, organized and existing under the laws of the State of Alaska. It addresses state and national public policy issues and involves approximately 400 of Alaska’s leaders and concerned citizens representing business, labor, education, public service and the Alaska Native community. It was founded in 1979 on a bipartisan basis by Governor William A. Egan and Governor Walter J. Hickel.

The goals of the organization include: Strengthening the private sector of our economy; Understanding Alaska’s role in the larger world; Educating members on major issues affecting our state and nation; Influencing state and national public policy decisions by providing a forum for nationally recognized speakers and conducting studies of critical issues facing the state and the nation.

COMMONWEALTH NORTH BOARD OF DIRECTORS Founding Co-Chairmen President Executive Director

Governor Walter J. Hickel Lee Gorsuch Pat Pourchot the late Governor William A. Egan

Skip Bilhartz, Vice President Bill Allen Robert B. Atwood

Perry Eaton, Vice President Richard F. Barnes Judy Brady

Jeff Lowenfels, Vice President Janna Brattain Fuller Cowell

Jane Angvik, Secretary Governor Steve Cowper Robert Hatfield, Jr.

Marc Langland, Treasurer Karen Hunt Archbishop Francis Hurley Jamie Linxwiler Loren Lounsbury Jim McElroy

Bill McHugh John Morgan Governor Bill Sheffield Susan Ruddy William J. Tobin Dr. F. Thomas Trotter

Commonwealth North Budget Study Committee

Chair: Lee Gorsuch Mike Abbott Jane Angvik Robert B. Atwood Judy Brady Milton Byrd Roger Cremo Gene Dusek Joe Griffith Karen Hunt Marc Langland Jim McElroy Bill McHugh Nancy McHugh Kristen Nelson

Susan Ruddy Larry Wiget Thomas A. Wilson II