Finding Alaska’s Future:FY 2018 Sustainable Budget

Interior Alaska Republicans, FairbanksAlaska Republican Assembly, Palmer

October 21, 2016

Brad Keithley (bgkeithley.com)President, Keithley Consulting, LLCFounder, Alaskans for Sustainable Budgets

Agenda

• What is a “sustainable budget”

• What is the FY 2018 sustainable budget

• How do we implement

Follow along at:

http://www.slideshare.net/bgkeithley

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What is a “Sustainable Budget”

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What is a “sustainable budget”

In a commodity based economy, a “sustainable budget” looks through the highs and lows of commodity prices and

charts a consistent, predictable, long termspending level that is

sustainable in all environments.

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Key Characteristics

• A sustainable budget • Depends on saving the “excess” when current revenues

are higher than long term sustainable number, and • Using resulting savings when current revenues are

lower than the long term sustainable number

• Is forward looking, so:• Uses projections about certain future developments,

and as a consequence• The “sustainable number" is subject to change as the

projections change (like most corporate forecasts), • But changes normally are in a fairly narrow range from

year to year and, if significant, can be moderated further by using moving averages or graduated transitions

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Key Components

• Calculates net present value (NPV) of future revenue stream from projected future oil (and gas) production • Not a valuation of “oil in the ground,” more a valuation of

government’s long term earning power

• Uses “other 50%” of PF earnings:• Gov. Hammond: "I wanted to transform oil wells pumping oil

for a finite period into money wells pumping money for infinity. … [Once the money wells were pumping,] [e]ach year one-half of the account’s earnings would be dispersed among Alaska residents …. The other half of the earnings could be used for essential government services.”

• Previously “other 50%” largely has been left in earnings reserve

• Budget level tracks inflation and population growth

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Key Projections Required

• Biggest: • Projected oil (and gas) price, production &

“government take” levels• Assumes forward spending is restrained to

“sustainable” levels (excess used to replenish CBR/ER)

• Significant:• The level of the “other 50%” of PF earnings (FY

2018, $1.3B)• Projected inflation and population growth rates• FY 2018 focus: correcting the statutory adjustment

for PF “inflation proofing“ (as PF has evolved, current provision overdraws for inflation)

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Critical Consideration• Calculation does not include PFD cuts or increased

taxes

• Why? These so-called “new revenue” sources – which really just transfer money from the private economy (i.e., PFD cuts or increased taxes) to the gov’t – aren’t revenue neutral, they subtract from a sustainable overall economy

• Because of adverse effect on overall economy, they should be limited (in amount and time) and used onlyto fill gaps between sustainable revenue and spending levels, if any• E.g., if sustainable level is $4B and spending $4.3B, “new

revenues” should be limited to difference, $300 million

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What is the FY 2018 “Sustainable Budget”

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Key Projections• Key oil (and gas) projections

• Oil price: EIA 2016 Annual Report “reference case” forecast (non-politicized projection)

• Oil Production: FY 2017 Spring RSB forecast, declining thereafter by 3% (largely discounts effect of potential new fields)

• Oil Gov’t Take: SB 21 stays in place going forward• Gas: Assigns 50% probability to #AKLNG startup

• Other key considerations• 50% of earnings used for PFD, “other 50%” is used to

support gov’t (FY 2018 “other 50%” = $1.3B)• Going forward inflation averages 2.5%, population

growth .75%

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Biggest factor

Crude Oil Spot Prices (Brent, $$nominal) Real ($2015)Growth(2015-40)

Case 2014 2015 2020 2025 2030 2035 2040

Low oil price $98.89 $52.32 $41.90 $53.12 $66.45 $88.81 $121.25 1.3%

Reference $98.89 $52.32 $84.59 $112.10 $140.69 $180.68 $229.22 3.9%

High oil price $98.89 $52.32 $166.43 $226.77 $284.43 $344.09 $397.03 6.1%

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Source: US Energy Information Administration, Annual Energy Outlook 2016 (July 2016), https://goo.gl/bAqh55.

… oil price forecast (non-politicized)

EIA oil price forecast

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FY 2018 Sustainable Budget

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UGF SUSTAINABLE SPENDING FY 2018 $4.02

Based on current & project revenue and use of financial asset income. Spending grows with inflation and population.

inflation 2.50%

population grow 0.75%

How do we implement

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How do we implement

• With one exception (correcting the PF “inflation adjustment” mechanism), implementing a sustainable budget doesn’t require new legislation, it simply requires discipline in the appropriations process.

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How do we implement

• Steps:1. Calculating the sustainable budget number at the

beginning of each session, e.g., $4.02 B (FY 2018)2. Setting – and enforcing -- a cap on overall real (no tricks)

UGF spending to the sustainable budget number.3. Fund spending using traditional UGF revenues, Gov.

Hammond’s 50/50 approach (after correcting the PF “inflation adjustment” mechanism), and if necessary

4. As Gov. Hammond envisioned, using the CBR & ERA savings (the accumulated “other 50%”) as balancing accounts (end of FY 2017 savings are projected to = $12.75B)

• Additional legislation setting out and requiring the steps may be appropriate if needed to enforce the necessary discipline in the process

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If spending falls above level …

• In the past, spending above sustainable levels essentially has been funded by taxing future Alaskans (“taxing our kids”)• By reducing the state’s fiscal assets has reduced the

future sustainable level below current spending

• Under a sustainable approach, each generation pays its own way• If current generation spends more, above their share of

long-term sustainable revenue, they pay for it themselves through taxes of some sort

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If taxes …

• Taxes (including PFD cuts, which are a form of taxes targeted at specific type of income) …• Pull money from the private economy, and

• Because of different multipliers between gov’t and private spending, have an adverse impact on the overall economy

• As a result, should be limited only to the difference between sustainable and spending level• Any more just leads to more spending …

“… remember the ‘revenue theory of costs’ for most nonprofits [including government] … holds that these entities spend all the money they get (allowing for prudent reserves). Savings come when there is less money to spend.” – Dr. Terrence MacTaggart

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Debate should focus on economy• Alaska already is in a recession, pulling more

money out of the private economy will make it even worse

• If taxes … • Choices among types (income, sales, property or PFD

cut) should be based on their relative impact to the overall economy; they aren’t all the same

• ISER’s March study is a useful guide to relative impacts• Interestingly, the study concludes

"The impact of the PFD cut … has the largest adverse impact on the economy ….“

• The Governor (and Senate) used the worst option, first

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Conclusion

• As a commodity based economy, Alaska should be using a “sustainable budget” approach

• The FY 2018 sustainable budget number is $4.02 billion; Alaska should be driving spending to that level

• Implementing a “sustainable budget” mostly requires legislative discipline, not new legislation• If the state can’t hold spending at the sustainable level,

it should tax the current generation for the difference, but only the difference

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A few fiscal facts …

How much is currently in the ER/CBR/SBR and PF Corpus? Currently projected balances as of the beginning of FY 2018 (July 1, 2017): $9.2B (ERA), $3.3B (CBR), $300M (SBR), $43B (PF corpus) (LegFinance, https://goo.gl/u1No6p at 3).

How much have we accrued in unpaid Oil & Gas tax credits?According to the Administration’s most recent estimate: $1.175B (FY 2018), with another $285M in FY 2019 and continuing at $150-200 thereafter (DOR, https://goo.gl/J05Ia1 at 2).

How much are current revenues?According to most recent projections: Traditional UGF: $1.25B (FY 2017), $1.35B (FY 2018) (DOR, https://goo.gl/uDwqYk at 8). “Other 50%”: $1.3B (FY 2017), $1.3B (FY 2018) (PFC, https://goo.gl/UiBbKh)

How much revenue would a broad based taxes raise?According to the Administration’s estimates: Income tax: $200M (6% of fed liability; DOR, https://goo.gl/evnpVB at 11), Sales tax: $418M (3%, DOR, https://goo.gl/GZ223E at 6).

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