New taxes, fund earnings thought to be fiscal solutions

Posted: Sunday, October 28, 2001

As Dickens said, it's the best and worst of times.

Financially, Alaska is in great shape.

The state has nearly $27 billion in its two largest savings funds, more than 11 times this year's budget for providing basic state services. That's a mountain of cash - roughly $43,000 per resident - that is unmatched by any other state.

But Alaska is headed toward a fiscal crisis.

With most of those reserves constitutionally protected in the Alaska Permanent Fund, and with most Alaskans so far unwilling to cap, reduce or give up their permanent fund dividends, a day of reckoning is at hand.

Sometime in the fall of 2005, the state is projected to exhaust its Constitutional Budget Reserve and face a $1 billion operating deficit, unless new revenue sources and savings are realized. That could make the Legislature's five years of budget cuts from 1996 to 2000 look like a Christmas shopping spree.

What are the chances of avoiding that cliff?

"It's impossible," says Clive Thomas, political science professor at the University of Alaska Southeast. "I think that human nature works against it. ... Inertia is the biggest force in life."

But Lt. Gov. Fran Ulmer said: "Doing nothing is a choice with ramifications. It may be more painful than the do-something option."

How did it happen?

Alaska faces this crisis because of the quirky way in which its fiscal regime evolved and also because of public sentiment about the permanent fund.

Alaska is the only state in the union that has neither a personal income tax nor a statewide sales tax.

Instead, the state overwhelmingly relies on one stream of income for government operations: oil.

When combining the industry's corporate income taxes, severance taxes, property taxes and royalties, oil contributed $1.95 billion to the state budget in the fiscal year that ended June 30, according to Larry Persily, deputy commissioner of revenue. That's more than 80 percent of the state general fund, which provides basic services, including education and public safety.

With the budget so extremely dependent upon one source of revenue, it's not surprising that budget forecasting and fiscal management are so fraught with difficulty. When oil prices fluctuate, so does the state's wealth.

"Our blessing's our curse," said Mike Bradner of Anchorage, co-publisher of a legislative newsletter for political insiders. "No other state's major revenue column does anything remotely like that."

"This isn't up and down like a roller coaster," Persily said. "This is up and down like a rocket that runs out of fuel."

Despite this history of budget volatility, the Legislature has done little to stabilize revenues. The only significant tax increase in recent years was a hike in the tobacco tax in 1997, Persily said.

The alcohol tax was last raised in 1983, for the first time in more than 20 years. The fisheries business tax has been at its current level since 1979, the marine motor fuel tax since 1977 and the highway motor fuel tax since 1970, Persily said.

In 1980, the Legislature, flush with oil money, repealed the income tax, retroactive to 1979.

In 1976, voters had established the permanent fund. At the time, the idea was to provide for future public services after the oil money ran out.

"Legislators absolutely felt this was money for a rainy day," said Bradner, who was speaker of the House when the constitutional amendment creating the fund was put on the ballot. "Nobody ever dreamed they'd be sending checks to people."

The dividends started several years later. Now they're viewed as a birthright.

"Today's privileges are tomorrow's demands," professor Thomas observed.

The sense of entitlement that developed around the permanent fund dividend led to a stunning special election in September 1999. More than 83 percent of voters rejected a plan to tap some permanent fund earnings to support government operations, despite strong backing for the plan from the state's political and business establishments.

In the Sept. 14 vote, "they equated the excess earnings and the permanent fund dividend," said former House Speaker Gail Phillips of Homer.

Pollster Ivan Moore said there were several messages embodied in the vote. About half of those who voted no said in a later survey that they wouldn't ever agree to using permanent fund money for government. Others objected to the vagueness of the plan or the way the "vote yes" campaign was conducted.

Gov. Tony Knowles joked in his 2000 State of the State speech that he and the Legislature had finally unified Alaskans. But legislators often refer to the special election in expressing caution about touching the permanent fund.

Now the dividend has become a political paradox, Bradner said. As residents received their $1,850 checks this month, many saw it as proof that the government is flush, so they discount warnings of a budget crisis, he said. But at the same time, they don't want government using that money to avert crisis.

So far, the financial cataclysm has been delayed by the Constitutional Budget Reserve, a fund established in the early 1990s to receive settlements from the state's litigation against the oil industry. In most recent years, the Legislature has had to draw money from the Constitutional Budget Reserve to fill out its general fund budget. This year, $1 out of every $4 in state services will come from the Constitutional Budget Reserve.

As of June 30, 2005, the Constitutional Budget Reserve is projected to be down to $285 million, and depletion is expected that fall, Persily said. There are no major settlements pending, he said. So while investment income will slow the rate of depletion, the Constitutional Budget Reserve's inevitable trend is steadily downward.

"People just don't buy that," pollster Moore said. "I don't know if it's general mistrust of politicians. You need to speak to a psychologist, because that's what it boils down to."

False hopes?

Some people hope natural resources can save the day.

But those who crunch the numbers say they doubt it.

Oil production is at half of its peak, down from 2 million barrels a day in 1988 to about 1 million now.

Early this year, there was natural gas fever at the Capitol, as lawmakers envisioned construction of a pipeline that would bring back boom times. Recently, the North Slope producers have said that the project doesn't look economically viable.

But even if it were, Persily says the rosiest possible scenario would be $400 million of annual revenue for the state as of 2008. That would be only 40 percent of the budget deficit that is expected to develop three years earlier. Natural gas revenues could be as low as $250 million.

Then there's the Arctic National Wildlife Refuge. The U.S. House has approved a bill for exploratory oil drilling on ANWR's coastal plain. But the issue is still tied up in the Senate. And even if approved now, no one knows how many barrels of oil there are. Even if the volume is commercially viable, it could take up to 10 years for the state to receive any revenue.

What about conventional economic development?

That's where the so-called "Alaska disconnect" kicks in.

"Normally what happens is when you have economic development, it brings in-migration -- people to fill those jobs, or at least a portion are taken by new people," said Scott Goldsmith of the Institute of Social and Economic Research at the University of Alaska Anchorage.

But with Alaska's tax structure, that's actually bad. The fresh faces won't be paying income and state sales taxes.

"These families put demand on services of both state and local governments," Goldsmith said. "There's no way to get revenue from the new households that move into the state."

Studies have shown that natural resource industries other than oil and gas "don't pay their way," contributing less than they cost the state to manage, Goldsmith said.

The fisheries tax pays for management of the industry only, he said. "There's nothing left over to pay for education of the fishermen's children."

New people also would mean more dividend recipients, lowering each resident's check.

Can't the Legislature just cut the budget?

Not without devastation.

The projected $1 billion deficit is 41.6 percent of the current general fund. If the general fund grows by 2005, so will the deficit.

The Republican majority cut $250 million from 1996 to 2000, making Alaska the only state with a shrinking general fund at the end of the decade. While Republicans say that's a key reason that the budget crisis hasn't already occurred, it also makes substantial further cuts unlikely, especially when the Legislature is under attack for the funding levels in public safety and education, particularly in rural Alaska.

And people are not so much in favor of budget cuts as is commonly supposed, Moore said.

In polling in 1999, Moore found that 70 percent of respondents wanted one quarter of the projected $1 billion deficit to be made up from more spending cuts. But when presented with the seven largest government agencies and asked how much they wanted to cut from each of them, those surveyed came up with total cuts of only 4 percent, he said. "I think your average person doesn't have an understanding of where the money goes."

Hard choices

The one sure thing about the eventual solution seems to be its breadth.

"I think ultimately what's going to fly is something that gets revenues from a lot of sources," Moore said.

"We're all going to get touched," said Ernie Hall, chairman of Alaskans United, a citizens group pushing for a long-range plan.

"I strongly support instituting a combination of modest taxes - progressive personal income, state sales, and increased gasoline and alcohol - using a portion of permanent fund earnings and trimming remaining budgetary fat to help bridge our fiscal gap," said Mary Griswold, a retiree from Homer.

This isn't new. Participants in Gov. Walter Hickel's 1992 Alaska Economic Summit were unanimous about the likelihood of a major fiscal gap and that no single remedy would be adequate.

One of Hickel's working groups concluded: "It is a political problem, not a money problem."

Most of the strategizing now is aimed at avoiding any major effect on permanent fund dividends. Although seven of Hickel's 10 working groups recommended a cap on dividends, no legislator recently has proposed a specific dollar limit.

Last year, then-Sen. Jerry Mackie briefly shook up the political world by proposing a final payout of $25,000 to every Alaskan, after which the remaining half of the permanent fund would be dedicated exclusively to funding government.

After a vigorous debate, the Mackie plan didn't go anywhere. Rep. Bill Hudson, a Juneau Republican, has broached the idea of a "mini-Mackie" that would make a smaller payment from the earnings reserve of the permanent fund and the Constitutional Budget Reserve, and that would suspend, not end, the dividend program. Under that plan, the fund's $21 billion principal would yield about $1 billion in annual investment income that could be used to plug the budget gap.

"I'm not even sure I could support it," Hudson said.

But the so-called "excess" or surplus earnings of the permanent fund are a tempting target for some lawmakers. Those earnings are what's left over after the dividend is paid and the principal of the permanent fund is inflation-proofed. In normal years, that would range from $125 million to $300 million. To date, nearly all of those funds have been plowed back into the principal of the fund or left in the earnings reserve account. Spending them eventually would mean less growth in dividends.

The Permanent Fund Corporation has proposed a constitutional amendment that would limit annual payout of the fund to 5 percent of the five-year average market value, an effort to build in long-term inflation-proofing. But that is still expected to leave a couple of hundred million dollars for possible legislative appropriation.

Former Gov. Jay Hammond, under whom the dividend program was established, said use of the earnings should be a last resort. It would be "asinine" to use permanent fund money, which only affects Alaskans, before implementing a broad-based tax that would make visitors and seasonal workers contribute, Hammond said. But Revenue Commissioner Wilson Condon has made the point that use of permanent fund earnings is the only budget-balancing tool that doesn't take money out of the state economy once the Constitutional Budget Reserve is gone.

There's also the concept of a second permanent fund, or endowment, using future natural resources receipts to set up funding for government only.

Rep. Carl Moses, an Unalaska Democrat, has proposed a municipal dividend program, setting some fund earnings aside for local police and fire, among other services. That would ease the burden of local property and sales taxes.

Other ideas include using permanent fund earnings for education or capital projects..

One proposal of Hammond's that is gaining popularity is some triggering mechanism for starting new taxes. That's seen as a way to help legislators avoid political repercussions by delaying the implementation of unpopular revenue-raising measures. Among the ideas are tying the trigger to the amount of money in the Constitutional Budget Reserve -- either $1.5 billion or $2 billion or to some level of oil revenue.

So, which taxes?

Hudson has introduced a bill to reestablish a state income tax, at 2 percent of federal income tax. That would raise about $200 million a year.

In late 1998, the membership of the Alaska State Chamber of Commerce narrowly defeated a proposed resolution endorsing an income tax, said President Pam La Bolle.

But the chamber does support a long-range fiscal plan with a broad-based tax, La Bolle said. That's not just for economic reasons, but also for civic ones, she said. "The public needs ownership. It's no skin off their nose (now) where the money's going to come from."

Other ideas:

Sen. Alan Austerman, a Kodiak Republican, has proposed a $100 "head tax" on each employee in the state.

Bradner said the gas tax needs to be raised. Each additional nickel would yield $15 million a year.

Senate President Rick Halford, a Chugiak Republican, has supported a $50 head tax on cruise ship passengers, which would raise about $35 million.

The oil industry might be asked to pony up more, perhaps through adjustment of the "economic limit factor" on certain fields.

Sales taxes could be in play, although some people say that would be unworkable because of existing municipal sales taxes in several cities. Each 1 percent of sales tax is estimated to raise $100 million a year, or $70 million with exemptions for food and medicine.

And there are some spending reductions in the mix of proposals.

"Small schools cannot be expected to have an Olympic pool or other large sports facilities," said John D. Lundy, a Wasilla geologist.

Hammond said the power equalization program that subsidizes rural electric bills should be based on need.

Some Republicans argue for dusting off proposals from a couple of years ago to turn some government functions over to the private sector.

Rep. Fred Dyson, an Eagle River Republican, wants to cut executive salaries, department overhead and travel, and eliminate programs where feasible.

Arliss Sturgulewski of Anchorage, a former Republican legislator and gubernatorial candidate, supports the so-called GARVEE bond approach to transportation infrastructure improvements, which would dedicate future federal highway funds to projects that can be jump-started now through the sale of debt. State officials say this method would cost the state nothing because investment income on the money would equal the small state match that's required.

Citizens can try their own hand at budget-balancing at, where there's a program called "How Would You Fill Alaska's Fiscal Gap?" By adjusting various budget assumptions, dividend levels and taxes, viewers can get a readout of how long the Constitutional Budget Reserve will last under each scenario.

For example, assuming 2 percent annual budget growth, the Constitutional Budget Reserve could be extended a year by capping dividends at $1,750, using permanent fund excess earnings, increasing alcohol taxes by "a dime a drink," levying a $50 cruise ship head tax and increasing the tax on oil and gas production by 10 percent.

Whatever the hybrid plan might turn out to be, it will be a political voyage with uncertain consequences.

"I've found that when explanations are made to the public, the public can be very responsible," Sturgulewski said.

But Austerman concluded: "Heads will fly, no matter which way you go."

Bill McAllister can be reached at

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