Scott Goldsmith: What Is a Sustainable Draw from the Permanent Fund?
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WHAT IS A SUSTAINABLE DRAW FROM THE PERMANENT FUND? Commonwealth North Fiscal Policy Study Group January 31, 2017 Scott Goldsmith Institute of Social and Economic Research University of Alaska Anchorage
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Transcript of Scott Goldsmith: What Is a Sustainable Draw from the Permanent Fund?
WHAT IS A SUSTAINABLE DRAW
FROM THE PERMANENT FUND?
Commonwealth North
Fiscal Policy Study Group
January 31, 2017
Scott Goldsmith
Institute of Social and Economic Research
University of Alaska Anchorage
Inevitable and Prolonged Tug of War
No Income
Tax!
No Sales Tax!
No Dividend
Cuts!
No More Budget Cuts!
Proposals for Use of PF Earnings
ACCESS TOTAL EARNINGS OF PF--POMV (Constitutional Endowment)– Fold Earnings Reserve into PF Corpus
– Draw 4.5% - 5% of PF value from PF Corpus
– Divide draw between UGF and PF Dividend
IMMEDIATE PLUG--SB114 (Statutory POMV)– Draw 5% of PF value from PF Earnings Reserve for UGF
– Pay PF Dividend from 75% of Royalties (with a floor)
STABILIZE REVENUE STREAM—GOVERNOR WALKER PROPOSAL (Statutory Sovereign Wealth Fund)– Dump SB21 revenues and additional 25% of Royalties into PF Corpus
– Draw % of PF value or $3.2 Billion from PF Earnings Reserve for UGF (inflation adjusted amount that sustains PF value)
CREMO PLAN (Constitutional Endowment)– Similar to POMV except ALL petroleum revenue deposited into PF
– Pay PF Dividend from 50% of Royalties
Which Draw Mechanism Produces
the Best Sustainability Tradeoff?
• Do we care about the future?
• What do we think the future will look like as petroleum production continues to fall?
A flow of income from current financial assets and the projected future petroleum revenue stream which, if adopted now, could be maintained consistently long into the future--adjusted for inflation and population growth.
Hypothetical Investment Rate of Return
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
Nominal Rate of Return
Real Rate of Return (RRR)
Inflation
One RRR Estimate
RRR : Actual History
Investment Nominal Rate of Return:
Where Should It Go?
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
Inflation
Proofing
PopulationAdjustment
Depletion
Allowance
Sustainable
Draw
NominalReturn
Nonspendable Fund Balance Assigned Balance: (Earnings Reserve)
Contributions Unrealized Gain
$40.7 + $5.3=$46.0 + $9.0 = $55
Current Practice: Inflation Proof Contributions
2017 Partial vs. Full
Inflation Proofing
CONTRIBUTIONS2.3 % x $41 billion = $941 Million
TOTAL FUND (POMV)2.3 % x $55 Billion = $1.27 Billion
Nonspendable Fund Balance Assigned Balance
Contributions Unrealized Gain
$40.7 + $5.3=$46.0 + $9.0 = $55
Inflation Proofing: Who Needs It?
Value of Contributions increases if Unrealized Gain counted
Unrealized Gains Accumulate in
Nonspendable Fund Balance
(Slow Turnover of Portfolio)
Statutory / Accounting Return = 50% Under spend today
Unrealized Gains Cashed out from
Nonspendable Fund Balance
(Fast Turnover of Portfolio)
Statutory / Accounting Return = 88% Over spend today
Unrealized Gains Cashed out from
Nonspendable Fund Balance
(In Between Turnover Rate of Portfolio)
Statutory / Accounting Return = 66%
Just Right spend today
Investment Nominal Rate of Return:
Where Should It Go?
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
Inflation
Proofing
PopulationAdjustment
Depletion
Allowance
Sustainable
Draw
NominalReturn
Will Need for Public Services Grow With
Population?
Other measures of the cost of government?
Alaska Population Growth
Investment Nominal Rate of Return:
Where Should It Go?
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
Inflation
Proofing
PopulationAdjustment
Depletion
Allowance
Sustainable
Draw
NominalReturn
Why a Depletion Allowance?
To Sustain the Total
Endowment from Petroleum
Reserves?
Sustaining the Endowment:
Transformation from Petroleum in
the Ground to Money in the Bank
PETROLEUMIN THE GROUND
MONEY IN THE BANK
STYLIZED HISTORY << >> FUTURE
Sustainable Deposit Rate depends on How Much Petroleum Revenue Remains to be Collected in the Future
Historical Depletion Allowance
Is this the right amount?
My Estimate:
“Owner State” Endowment
* Estimated Net Present Value of Future Petroleum Revenue
TOTAL (FY 2018) $98 Billion
In the Bank $57 Billion
In the Ground* $41 Billion
Known Conventional Oil $25 Billion
Other Oil $5 Billion
Gas $11 Billion
Assumptions:Optimally Manage What We Can Control
Known Conventional Oil Production Decline @ 4%Oil Price tracks ADOR, then 3.5% growth
New Conventional OilNPRAHeavy OilShale Oil
Gas Commercialization in 2026 Gas Revenues to State $1.00/mcf
Real Rate of Return on Investments 5.0%
Population Growth Rate .5%
Inflation Rate 2.25%
How Much Can We Spend Today
from the Endowment?
NEST EGG (FY 2018) $98 Billion
Multiply: MSY Take Rate 4.5% (5%-.5%)
Equals: MSY Take $4.4 Billion
Current Petroleum Revenues (fluctuates yearly) ?
Investment Income (endowment draw minus current petroleum revenues)
$4.4 Billion - ?
Minus: PF Dividend $ 1.4 Billion
Equals: Endowment Draw for UGF $ 3 Billion
Plus: Non-Petroleum GF Revenues $ .5 Billion
Equals: UGF MSY $ 3.5 Billion
Sources for UGF Spend
Transition of UGF Spend down to $3.76 Billion in 2021 before resuming growth
Sources for UGF Spend: Random Oil Price
Use of investment income fluctuates yearly.
Financial Draw is Residual
to Hit Sustainable Spend Target
Wrap Up
• Sustainability should be based on ENTIRE Endowment
• Sustainable draw depends on size of ENTIRE Endowment
• Fixed draw rate from financial asset does not account for• Depletion of petroleum asset• Variation in petroleum revenue from price
fluctuations
• POMV with doubling of Royalty Deposit into PF would provide an approximate solution
• Implementation of limit on spending from Endowment based on Sustainability Analysis would be best solution (but politically challenging)
Good News Scenario?
Known Conventional Oil Production Decline @ 4%Oil Price exceeds ADOR Forecast
New Conventional OilNPRAHeavy OilShale Oil
Gas Commercialization in 2026 Gas Revenues to State $1.00/mcf
Real Rate of Return on Investments 5.25%
Population Growth Rate .5%
Inflation Rate 2.25%
Nest Egg $103 Billion
MSY $4.9 Billion
GF MSY $4.0 Billion
$4.0 billion UGF can grow with inflation & population
Best News Scenario?
Known Conventional Oil Production Decline @ 4%Oil Price exceeds ADOR Forecast
New Conventional OilNPRAHeavy OilShale Oil
Gas Commercialization in 2026 Gas Revenues to State $1.00/mcf
Real Rate of Return on Investments 5.25%
Population Growth Rate 0%
Inflation Rate 2.25%
Nest Egg $103 Billion
MSY $5.5 Billion
GF MSY $4.5 Billion
$4.5 billion UGF can grow with inflation
Bad News Scenario?
Known Conventional Oil Production Decline @ 4%Oil Price tracks ADOR Forecast, then 3% growth
New Conventional OilNPRAHeavy OilShale Oil
No Gas
Real Rate of Return on Investments 4.5%
Population Growth Rate 0%
Inflation Rate 2.25%
Nest Egg $86 Billion
MSY $3.9 Billion
GF MSY $2.9 Billion
$900 per capita tax allows UGF to grow from $3.76 billion starting in 2021
Worst News Scenario?
Known Conventional Oil Production Decline @ 4%Oil Price tracks ADOR Forecast, then 3% growth
No New Conventional OilNo NPRANo Heavy OilNo Shale Oil
No Gas
Real Rate of Return on Investments 4.5%
Population Growth Rate .5%
Inflation Rate 2.25%
Nest Egg $81 Billion
MSY $3.2 Billion
GF MSY $2.3 Billion
$1,750 per capita tax allows UGF to grow from $3.76 billion starting in 2021
Alternatives Moving Forward:
Cost / Benefit Analysis
Tradeoff for one year is less revenue ($600 million) against a stronger economy.
Which do you prefer?
BASE CASE BAD NEWS
WHAT IS A SUSTAINABLE DRAW
FROM THE PERMANENT FUND?
Commonwealth North
Fiscal Policy Study Group
January 31, 2017
Scott Goldsmith
Institute of Social and Economic Research
University of Alaska Anchorage
