Conflicting legal opinions lead to discrepancies in Alaska state finances totaling more than $1.6 billion

Conflicting legal opinions have led to discrepancies in the state’s finances totaling more than $1.6 billion, according to a legislative audit that detected 91 issues with the state’s money management and reporting last year.

The largest problems identified in the 2020 fiscal year Statewide Single Audit released June 3 by the Legislative Budget and Audit Committee resulted in a qualified opinion of the state’s financial statements from Legislative Audit Director Kris Curtis.

“State of Alaska’s General Fund rents and royalties are not reported in accordance with generally accepted accounting principles and management declined to correct the misstatements. Misstatements include an unreported General Fund prior period adjustment of $199.0 million for overstated General Fund royalty revenues of $99.8 million in (fiscal year 2018) and $99.2 million in (fiscal year 2019), and an understatement of $199.0 million due to other funds,” Curtis wrote in her Independent Auditor’s Report to committee members dated Feb. 22.

The root cause was the decision by Department of Natural Resources officials to transfer mineral royalty revenues owed to the Permanent Fund to the General Fund instead, according to the audit report.

Additionally, the Constitutional Budget Reserve, the state’s primary — and dwindling — savings account “is materially misstated by $1.6 billion” and Revenue Department officials have also declined to correct the error, she wrote.

The alleged misstatements in the state’s financial records stem from decisions made by former Gov. Bill Walker’s administration to put more money in the General Fund at a time when state was, and still is, running significant annual deficits.

Tariff settlement

Former Attorney General Jahna Lindemuth wrote to Curtis in October 2018 insisting that Department of Revenue officials appropriately put oil tax revenue in the General Fund that previously would have gone to the CBR based on her recommendation.

According to the 630-page audit and report, the Federal Energy Regulatory Commission in 2016 and 2018 reduced the tariff rates the Trans-Alaska Pipeline System owner companies — the North Slope oil producers — could charge for using the pipeline, thereby increasing the net production tax they owed on the oil throughput since 2010.

The Revenue Department ultimately collected $201.5 million in retroactive taxes and interest when the tariffs were applied and put it in the General Fund. Prior to that, money collected from FERC decisions, which are the result of litigation, was put in the CBR as the constitutional amendment establishing the savings fund directs all settlement revenue into it.

In Lindemuth’s opinion, which the Dunleavy administration has adhered to, the tariff changes resulted in a change to the net tax the producers owed and all tax revenue goes to the General Fund.

Conversely, Legislative Legal Director Megan Wallace wrote in a September 2018 memo to Curtis that the revenue stemming from FERC decisions must go to the CBR because it “seems to fit within the category of ‘windfall revenue’ the framers of the CBR amendment intended to be deposited into the CBR.”

Further, the tariff-related tax revenue was the outcome of federal litigation the state was a party to, and even if the state had not participated in the suit it would have eventually sought to collect it from the producers based on the terms of the settlement “and any additional revenue received by settlement or otherwise would undeniably be deposited into the CBR,” according to Wallace.

Curtis has adhered to Wallace’s advice and wrote in her audit report that based on the attorney general opinion, money deposited into the CBR under the prior guidance “should be reclassified as General Fund monies, thereby reducing the amount that the General Fund must repay the Constitutional Budget Reserve Fund in the future. Legal analysis does not support the attorney general’s opinion.”

The CBR currently holds just more than $1 billion and the General Fund along with a handful of other state investments total nearly $2.6 billion, according to the Revenue Department.

Royalty revenue

As for DNR, the audit states that administration officials under Walker asked the Legislature to reduce the amount of royalty revenue allocated to the Permanent Fund to again increase available revenue for fiscal years 2018 and 2019. While at least 25 percent of all mineral royalties collected are constitutionally mandated to the fund, in 1980 the Legislature directed 50 percent of all royalty revenue from future state leases to the Permanent Fund.

“The Legislature made the reduction by omitting from the FY 18 and FY 19 annual operating budget bills a reference to (the 1980 statute). Although there was no appropriation for the post-1980 lease revenues, the governor’s Office of Management and Budget instructed DNR staff to transfer 25 percent of the post-1980 lease revenues to the (Alaska Permanent Fund). The transfer occurred without an appropriation,” the audit states.

Lindemuth at the time argued that the 1980 law could not explicitly dedicate the additional revenue to the Permanent Fund and therefore the transfer did not need an appropriation to be legal.

Legislative Budget and Audit chair Sen. Natasha von Imhof, R-Anchorage, said that what is often described as a “friendly lawsuit” is likely needed to resolve the diverging views with a court ruling since the Supreme Court has not dealt specifically with these matters before.

“There needs to be a discussion with the Legislature, along with Megan Wallace and (Legislative) Legal to decide how we want to go forward with this,” von Imhof said in an interview.

“I think we’re going to have to have the courts decide whether this money needs to go to pot A or pot B.”

She noted that while the biggest practical implication of the dispute is what vote threshold needs to be cleared to spend the money is significant — the CBR requires a three-quarters supermajority vote in the Legislature and for the General Fund it is a simple majority — the state still has the money regardless.

Lawmakers were considering ways to fix the issue early in 2020 before the pandemic halted court proceedings, according to von Imhof.

Legislative Budget and Audit member Rep. Andy Josephson, D-Anchorage, said that the FERC-derived collections probably should go to the CBR but also questioned the importance of the distinction.

“On the other hand, I don’t know as an academic point what the difference would be because we likely would’ve spent it out of the CBR because that’s what we’ve been doing,” Josephson said.

His primary concern is that the differences have led to a qualified opinion of the state’s finances.

“I don’t know to what extent that is a red flag to the federal government,” Josephson added.

Anchorage Democrat Sen. Bill Wielechowski, who filed the suit against former Gov. Bill Walker for his partial veto of the Permanent Fund dividend appropriation in 2016, said Curtis is one of the most universally respected officials in state government, particularly for her objectivity.

Wielechowski said a suit by the Legislature or someone in the public against the administration would be a way to resolve the issues, or the administration could “just do what Kris Curtis is recommending and go ahead and transfer those funds to the appropriate places.”

The Supreme Court’s ruling in Wielechowski’s lawsuit that reinforced the Legislature’s ultimate appropriation authority largely set the precedent for subsequent money moves that have conflicted with statute, both by the Legislature and the state administrations.

Wielechowski emphasized that having the money in the General Fund as opposed to the CBR creates a whole different political dynamic given the vote requirements.

He said he was struck by the top line numbers of 94 findings of noncompliance and 41 unresolved issues that include some of the constitutional questions.

The reporting issues are spread throughout agencies, including equipment rentals made outside of required bidding processes, mishandled Medicaid funds and other accounting misstatements, Wielechowski said, which require better controls in state agencies.

“Those are things I’ve always paid extra attention to because that’s preventing waste; it’s preventing cronyism. You have procurement rules for a reason,” he said.

Von Imhof said there is likely a “multi-pronged answer” to the seemingly high number of discrepancies and other issues in the audit. She has asked Curtis to dissect the alleged misstatements in a spreadsheet to parse out any themes or trends among them.

“The large one is we seem to have a brain drain of I think seasoned, several-year employees that have left the state and we just have newer, less-experienced accountants and I just think there is some institutional knowledge that may have been lost,” von Imhof said.

When asked about the audit June 7, Dunleavy said he had not yet reviewed it and couldn’t comment.

Curtis wrote in an April 28 letter to Dunleavy attached to the audit that the 2020 fiscal year report included 94 findings and the 41 that were unresolved from prior years.

“With your active support and encouragement, we hope to see improvement in the implementation of corrective action for these findings by the state agencies,” Curtis wrote to the governor.

Josephson said he also believes a high turnover rate among state staff is a contributing factor and suggested a long-term solution would be to bring back defined benefit pension plans for state workers in an attempt to make long-term state employment more appealing.