The Legislature’s historic decision

On Tuesday, legislators in Juneau made a historic decision.

They opted to shift our state government's financial framework away from a dangerous dependence on volatile oil revenues to one where the earnings of our $64 billion Alaska Permanent Fund can help pay the bills.

As all Alaskans should know, the Permanent Fund is our savings account. We stash 25 percent of oil and minerals (miners pay it too) royalty income into the fund, and 50 percent of royalties from some oil leases.

There were two major steps to this decision. The first was the decision to fund the upcoming fiscal 2019 budget partly with earnings from the fund.

The second step was to establish the rules for the annual withdrawals, which cleared the House and Senate on Tuesday in the form of Senate Bill 26.

Remember that the Alaska Constitution does allow the earnings of the fund to be appropriated by the Legislature, and these earnings have averaged nearly $3 billion a year for the last five years. The principal of the fund cannot be spent, however.

Although the fund's earnings have always been available for appropriation, they have never been used except to pay the annual Permanent Fund dividend, or PFD, and to make "inflation-proofing" payments from the earnings back to the principal.

As with the dividend, the Legislature must make an appropriation for inflation-proofing, and this has not been done for three years. Meanwhile, the fund's income has accumulated in an earnings reserve account and now totals $17 billion.

It is this money, the earnings from our saved oil royalties, that will be used to partly finance the state budget in fiscal 2019, which begins July 1.

It's the first time for this, and it's historic. Many say it's why we created the Permanent Fund in 1976 in the first place — to help pay the bills when the oil revenue winds down. There are, of course, complications.

As we do this, we have to be cautious and make the withdrawals in an orderly way and not take too much. If we do it properly, the earnings reserve will be refilled every year and we'll still have money for the annual PFDs, which are important to many Alaskans.

The rule the Legislature has settled on, after much discussion, is a percent-of-market-value, or POMV, rule for withdrawals that is commonly used by large endowments, such as for major universities. The trick is to use a percentage that is below the expected earnings and including inflation in the calculation, so that the endowment — the principal of the permanent fund, in our case –is sustainable.

What's also important is to use an average of several years' earnings, not the most recent year. That way the effects of good years and bad are smoothed out. In 2009, for example, our Permanent Fund actually lost money. In 2016 and 2017, we had extraordinarily good years. Averaging is important because we don't want to replace volatile oil revenues with volatile financial income.

The plan the Legislature passed this week would base the payout on 5.25 percent of the fund's total market value for three years and then 5 percent thereafter. The averaging is included, so the actual withdrawal, with the percentage based on the fund's average value over five years, would be 4.5 percent.

As an illustration, this would work out to about $2.8 billion per year for both the budget and the dividend. Again, for illustration, if a $1,600 dividend is assumed (the amount set for 2018), that would require about $1 billion, leaving about $1.8 billion available for the budget. Doing the math, we can add about $2.2 billion in normal state income (still mostly in the form of oil revenue) and we arrive at a total of about $4 billion.

That's still $600 million below what's needed to fund the fiscal 2019 budget, which is expected to total about $4.6 billion in unrestricted general fund expenditures.

Luckily, we still have some money in another savings account, the Constitutional Budget Reserve, to cover the FY 2019 general fund deficit. We can only draw down the CBR for one more year, however. The state administration uses the account for cash management through the year to meet payroll and general operating expenses, so we need to always keep at least $1 billion — or, more prudently, $2 billion — in the CBR.

Another awkward truth is that there are certain built-in factors in the budget that will drive costs upward, such as inflation and health care.

The bottom line is that we're not out of the woods financially. We're taking a big, historic step with the use of Permanent Fund earnings but eventually there will have to be another revenue source, ideally a broad-based tax like an income tax or state sales tax.

Alaskans don't like to hear the word "tax," but I believe it's a reality that will face us sometime soon. Residents elsewhere have long paid state taxes, often hefty ones, but Alaskans have been cushioned.

There will be a vigorous debate about all this through the summer and fall political campaigns, however, so we should all keep an open mind. There may be creative ideas out there we haven't thought of.

It's nice to have that luxury.