ALASKA'S REVENUE FORECASTS AND EXPENDITURE OPTIONS

Transcription

1 REVEW OF SOCAL AND ECONOMC CONDTONS UNVERSTY OF ALASKA, NSTTUTE OF SOCAL AND ECONOMC RESEARCH, JULY 1978, Vol. XV, No.2 ALASKA'S REVENUE FORECASTS AND EXPENDTURE OPTONS NTRODUCTON Can Alaska's state governent continue to increase the level of services it provides? n an era of prosperity, when oil and associated revenues, are forecast to contribute billions of dollars to the state treasury over the next 15 to 2 years, the answer would appear to be an unqualified "yes." Howver, recent research by the nstitute of Social and Econoic Research has revealed that even odest increases in the level of services provided by the state could result in a state operating deficit as early as 1987 and an absolute deficit by How could a fiscal crisis be a possibility in light of recent predictions of revenue growth? The fiscal proble arises because of the state's increasing dependence on petroleu revenues to finance operations. This dependence is increasing with tie in spite of the fact that petroleu revenues cnot continue to grow indefinitely and will likely de'cline significantly, in absolute ters, in the late 198s. This Review exaines the historic pattern of state expenditure growth and shows how this growth has been affected by growth of petroleu revenues. t shows that, cobined with various estiates of future revenues, past expenditure practices, if continued in the future, will result in a very large general fund surplus during the early 198s, but a total dissipation of surplus revenues by the end of the decade. Should this happen, it will leave the state the alternatives of either severely reducing the level of state services or significantly increasing taxes. Several fiscal options, including the use of the peranent fund, are discussed as ethods for dealing with this long-run fiscal proble. THE GROWTH OF STATE EXPENDTURES Since statehood, Alaska has experienced nearly two decades of substantial econoic growth. The resident population has grown at the rapid rate of 3.8 percent per year fro 226,2 persons in 196 to an estiated 413,3 persons in Accopanying This research was partially funded by the qepartent of Revenue; the Division of Policy Developent and Planning, Office of the Governor; and the Legislative Affairs Agency. The future financial health of Alaska's State Governent is one of the ost crucial, and least understood, challenges facing Alaskans. t is hoped--that publication and distribution of this study will encourage further thought, research, and discussion of this subject. t should be noted that these estiates have not as yet been updated to include the recent tax changes enacted by the second session of the tenth Alaska Legislature(e.g., changes in oil taxation, personal incoe taxes, and the business license tax). Further, the projections given in this paper represent official state estiates of revenues and expenditures only when so noted.

2 - --- PAGE 2 UNVERSTY OF ALASKA, NSTTUTE OF SOCAL AND ECONOMC RESEARCH ALASKA REVEW OF SOCAL AND ECONOMC CONDTONS VOL. XV, No.2, June 1978 Published by nstitute of Social and Econoic Research University,,f Alaska Anchorage Fairt.. ks Juneau Editor: Ronald Crowe Production: Kandy L. Crowe 8th Floor, Gruening Bldg. University of Alaska Fairbanks, Alaska Director: Lee Gorsuch 77 "A" St. Suite 26 Anchorage, Alaska FEATURE. Scott Goldsith Alaska's Revenue Forecasts and Expenditure Options BOOK REVEWS Arthur E. Hippler 22 The Eskios and the Aleuts, By Don E. Duond People fro Our Side: An Eskio Life Story in Words and Photographs, by Peter Pitseolak and Dorothy Eber. Scott Goldsith is an assistant professor of econoics and Arthur E. Hippler is an associate professor of anthropology. Both are staffebers of the nstitute of Social and Econoic Research in Anchorage. Alaska's population growth has been an even ore rapid growth in state spending. This spending growth, shown in Table 1, has been continuous, fro a level of $36.6 illion in 196 to $895.1 illion in While population growth cobined with inflation accounts for a substantial portion of the growth in state spending, particularly in the high inflation years of 1973 to 1977, it obviously does not account for the doubling of state spending that occurred between 1969 and 1971, following the discovery of oil at Prudhoe Bay. To understand and assess past state expenditure behavior, one ust exaine it in light of: (1) total expenditures, (2) population, and (3) the rate of inflation. Based on this inforation, one can deterine state expenditures per capita as well as real expenditures per capita (which take into account the ipact of inflation). Thus, if a policy goal were to aintain a given level of service to all citizens, real spending per capita would be the appropriate easure, and constant real spending per capita would approxiate a constant level of governent services to individuals. A growth in real spending per capita would iply an increased level of service, and a decline would iply a diinished level of service. As shown in Figure 1, between 1961 and 1976, both per capita state expenditures and per capita incoe grew substantially; however, while per capita incoe grew at an annual rate of 8 percent, per capita state expenditures grew at nearly twice that rate, or 16 percent. As a result, state spending, expressed as a percentage of personal incoe, grew fro 8 per.cent in 1961 to 2 percent in t is apparent on exaination of the historical series in Table 1 that since statehood, Alaska has experienced three distinct patterns of spending over three periods of tie. These periods are: 1961 to to to the present. Between 1961 and 1969, prior to the Prudhoe

3 (1) (2) Total Operating Expendituresa Expenditure Per Capitab Year (illion$) ($) o : ,9 1,128 1, c q , ,885 t;' ! (est) 1,47. Table 1 State of Alaska Operating Budget Analysis (3) Real Expenditure Per Capitac (1967 $) ,63 1, ,149 (4) (5) Ratio of Real Expenditures Personal to Real ncoe ncoe Per Capitad (%) Per Capita ($) 8 2, , ,53 1 3, , , , , , , ,51 2 5, , ,618 (6) Real Personal lncoee (illions of 1967 $) ,42.2 1,97.8 1, , , ,5.5 1, , ,321.8 (7) Anchorage Consuer Price lndexf (1967=1) (8) Population (thousands) c z < :: =i "' -<, )> r )> "'?' "' z "' -! =i c -!, "' Q )> r )> z (') z $; (') :: "' )> :: (') Annual Rate of ncrease,% a Alaska, Office of the Governor, Division of Budget and Manageent, The Executive Budget Annual issues 1961 through boerived by dividing colun 1 by colun 8. coerived by dividing colun 2 by colun 7. doerived by dividing colun 3 by colun 5. eu-.s. Departent of Coerce, Bureau of Econoic Analysis, unpublished data, deflated by Anchorage consuer price index. fu.s. Departent of Labor, Bureau of Labor Statistics, "Consuer Price ndex-pacific Cities and U.S. Average," (bulletin), various issues 196 through )> " Gl w

4 PAGE 4 UNVERSTY OF ALASKA, NSTTUTE OF SOCAL AND ECONOMC RESEARCH 6 1l :'i --' u; :::i,._ <. "' u. "' z <( "' :J f- 4 2 REAL PERSONAL NCOME PER CAPTA REAL STATE GOVERNMENT EXPENDTURES PER CAPTA YEAR Figure 1. The Growth of Governent Expenditures and Personal ncoe. (in Real Per Capita Ters) Bay lease sale, the operating budget grew at a 17-percent annual rate. After correcting for price level cho.nges and population growth, this is equivalent to 1 percent in real per capita ters. This period of expansion of state governent services resulted fro the requireents of transition to statehood. State expenditures, as a percentage of personal incoe, rose fro 8 percent to 12 percent. Historically, the growth of state expenditures has closely followed that of personal incoe in ost states. This is because personal incoe is an indicator of the tax base of the state, which is the state's ability to pay for services, and also of the deand for state ervices, which typically rises with incoe. During this period, expenditure and revenue growth atched, leaving neither a surplus nor deficit in the general fund. n contrast, between 1969 and 1972, total operating expenditures grew at an annual rate of 34 percent. This rate, adjusted for inflation and population, equaled 26 percent in real per capita ters. The operating budget doubled in less than 3 years, and state expenditures as a percentage of personal incoe nearly doubled, increasing fro 12 percent to 2 percent in 2 years. This jup in expenditures, which was ade possible by the revenues the state derived fro the 1969 Prudhoe Bay lease sale, severed the close relationship between increases in Alaskan personal incoe and state expenditures. During this period, the $9 illion

5 UNVERSTY OF ALASKA, NSTTUTE OF SOCAL AND ECONOMC RESEARCH PAGE general fund surplus derived fro the lease sale was heavily drawn upon and significantly reduced. Contrary to conventional opinion, growth in the state budget has oderated since 1972 and has, in real per capita ters, grown at the slowest rate the state has experienced since statehood. Between 1972 and 1978, the budget increased at a rate of 19 percent annually, which, corrected for population growth and the Axceptionally high inflation rate during the period, equals only 4 percent in real per capita ters.l Despite oderation in growth of real spending per capita, the size of the budget has grown ore rapidly in recent years than in the iediate post-statehood period. This experience highlights the significant effects that inflation and population have on the state budget. Because a large part of recent budget growth has erely reflected an attept to keep pace with population and price increases, the ratio of state expenditures to personal incoe has reained at the 2 percent level it reached in The possibility of an increasing level of governent services in the future will ultiately depend upon the availability of revenues; thus, the pattern of future expenditures ay bear little reseblance to the past. However, it is the historical growth rate of expenditures that conditions expectations of future growth. Historically, expenditures have grown steadily as personal incoe has grown, except when revenues have increased suddenly. When that occurred between 1969 and 1972, expenditure growth far exceeded the growth of personal incoe. This rapid growth resulted in a uch higher ratio of state expenditures to personal incoe, which has subsequently been aintained. COMPOSTON OF STATE REVENUES Given that state spending for the past 17 years has increased at an annual rate of alost 2 percent and that the ratio of state spending to personal incoe has grown fro 8 to 2 percent during this period, it is iportant to understand the sources of revenue growth in the past and the potential for growch in the future. Figure 2 shows one possible pattern for the growth of state revenues between the present and the year 2. n this projection, rapid growth of total revenues in the 198s is followed by a long period of decline in the later 198s and the 199s. Between 1977 and 1986, revenues increase fro $117.1 illion to approxiately $28 illion (1977 lreal spending per capita actually declined between 1973 and 1976, but increased again in dollars). This is an annual growth rate of 1.9 percent in real ters or about 16 percent in noinal ters. Subsequently, revenues fall in each year, declining to $17 l'\illion by the year 2 (1977 dollars). The ain coponents of revenues are also shown in Figure 2. Because the coponents exhibit different growth patterns, each coponent requires separate analysis. The four ain revenue coponents are: 1. Petroleu revenues. 2. Nonpetroleu revenues (taxes, licenses, fees, and iscellaneous revenues). 3. Earnings on fund balances. 4. Federal grants-in-aid. Figure 3 shows the distribution of total revenues aong these sources for selected years and Table 2 provides a ore detailed historical suary of revenue sources. Peroleu Revenues Typical of the early years of statehood, petroleu revenues, consisting priarily of production taxes and royalties, accounted for little ore than 11 percent of general fund revenues in 1965 (Figure 3). n ore recent years, large bonus payents, property taxes on oil- and gas-related production facilities, and reserve taxes on the aount of producible oil and gas in the ground have caused the aount and percentage of petroleu revenues to increase substantially. n 1977, 42.7 percent of general fund revenues were derived fro petroleu. This increase has not been sooth, as the annual contribution of petroleu to the general fund has varied considerably. n future years, petroleu revenues will continue to contribute significantly to the general fund, although there is a large degree of uncertainty concerning the level of those revenues. Aong the factors upon which this level depends are: Alaska recoverable oil and gas reserves. The refinery price of crude oil. a The arket price of gas. Market locations for Alaska oil and gas. e Oil and gas transportation costs. e Federal energy policy. Alaska tax policy. A reasonable set of assuptions extrapolated fro present conditions would result in petroleu revenues accounting for 38.7 percent of revenues in 199. This extrapolation is based on the following assuptions: 1. Prudhoe Bay oil is assued to sell at the refinery for $ per barrel in 1978, and

6 PAGE 6 UNVERSTY OF ALASKA, NSTTUTE OF SOCAL AND ECONOMC RESEARCH 3. r , '...,... ',... "' a: <: -' -'... :;; u. "' z :::; -' Cii , "o-, <1( ry ---Vs-1\1..._ ul:s PETROLEUM REVENUES -, /' /, / " // // '\ ' ',.,,.Gs '\..., <t-,-""' --..._ ENUES / -... ;"t-... NON PETROLEUM REV """ -... "v......_... u ::::;:.,_.-1'.... ;EAL GRANTS-lN-AlD...,...,.., L YEAR Figure 2. Pattern of Future State Revenues. its price to increase 5 percent annually. A $4.9 pipeline tariff and an additional charge for shipping fro Alaska tidewater to the lower 48 of $1.5 (increasing to $2.5 by 198) deterines the wellhead price, which begins at $7.35 and will rise to $11.95 in 1985 and approxiately 6 percent annually thereafter.2 1The 8 billion barrels of recoverable oil in the field and axiu throughput of the pipeline of 1, 7 illion 2Because of the state's inability to arket all of the Prudhoe Bay crude oil on the U.S. West Coast and the ongoing litigation over the proper(level for the pipeline tariff, the actual wellhead value in FY 1978 has been substantially below this estiate. barrels daily dictate that production will begin to decline in 1986, and state revenues fro Prudhoe Bay oil will begin to decline in the following year if the present tax structure continues in force. 2. Prudhoe Bay gas production will begin on a large scale in 1983, with the copletion of a pipeline capable of transporting approxiately 2.5 billion cubic feet of gas daily. For purposes of calculating state revenues fro royalties and production taxes, the wellhead value of the gas is assued to be $1. per thousand cubic feet. 3. Cook nlet production of oil and gas will gradually decline fro its present level.

7 UNVERSTY OF ALASKA, NSTTUTE OF SOCAL AND ECONOMC RESEARCH PAGE 7 n spite of the uncertainty surrounding future levels of petroleu revenues, the state should conduct policy analysis on the basis of the best available inforation at hand. As new inforation becoes available, the above assuptions should be odified and the revenues re-estiated, resulting in a continuous process of policy and fiscal analysis. The petroleu industry is actively exploring prospects in Alaska on federal, state, and private lands. New discoveries of econoically recoverable petroleu reserves would lead to substantial revenues to the state only if discoveries occurred on state or private lands. At this tie, any attept to estiate state revenues fro unproved fields would be highly speculative. Furtherore, in defining a feasible strategy for long-run state spending, it is inappropriate to use such a speculative estiate for revenues. A ore satisfactory ethod would be to use a conservative estiate of petroleu revenues based on known reserves. This would iniize the probles that could result fro overestiating state revenues. f such an estiate proved to be too low, the level of spending would be easy to increase. Despite uncertainties over the aount of future oil-related revenue that will accrue to Alaska because of fluctuating prices, production, and tax rates, the pattern of future petroleu revenues can be anticipated. Revenues will rise as production increases, reach a plateau, and finally decline as petroleu is depleted. Figure 2 shows that petroleu revenues, according to the assuptions outlined above, will reach a peak of $1.75 billion (in 1977 dollars} in 1985 and then decline as the resource is depleted. n 199, projected revenues would be $.9 billion. Different assuptions about resenres, prices, and taxes can change the level of revenues over tie, but not the basic pattern. Nonpetroleu Revenues (Taxes, Licenses, Fees, and Miscellaneous Revenues) Most other sources of revenue are unrestricted general fund revenues generated as taxes, charges for services, license receipts, and resource revenues. Figure 3 indicates that these nonpetroleu revenues accounted for alost the sae percentage of revenues in 1965 as in 1977: 31.8 percent in 1965 and 33.2 PETROLEUM REVENUES 38.7% REVENUES 18.4% PETROLEUM NON-PETROLEUM REVENUES REVENUS 31.8% 11% FUND EARNNGS; 1.5% FUND EARNNGS FEDERAL 3A% GRANTS-N-AD 56.7% FUND EARNNGS 28.4% FEDERAL GRANTS-N-AD 2.7% NON-PETROLEUM REVENUES 33.2% MLLON DOLLARS 117,1 MLLON DOLLARS 3633,5 MLLON DOLLARS (Estiated) Figure 3. Distribution of Sources of State Revenue in Noinal Dollars.

8 Gl "' Table 2 Historical Suary of Alaska State Revenues (illion $) Petroleu Nonpetroleu Federal Total Petroleu Revenues as Nonpetroleu Revenues as Federal Grants-in-Aid General Fund Revenues 8 Percentage Revenuesb Percentage Grants-in-Aid as Percentage Year Revenues (unrestricted) of Total (unrestricted) of Total (restricted) of Total , ' , ' average annual growth rate (64-77) 18% 31% 19% 9% 3 1ncludes production, property and reserves taxes, ineral leases, bonuses and royalties, and federal royalty sharing with the state. Non-Federal Restricted RevenuesC blncludes general fund earnings. en on-federal restricted revenues consist priarily of interagency receipts and as such are not considered revenue generated by the private econoy. SOURCE: Alaska Departent of Adinistration, Annual Financial Report, annual issue 1964 through Non-Federal Restricted Revenues as Percentage of Total c z < : (J) =i -< " )> r ;; A }> z =i c --1 "(J) () )> r )> z () z s: () : (J) )> : ()

9 UNVERSTY OF ALASKA, NSTTUTE OF SOCAL AND ECONOMC RESEARCH PAGE 9 percent in 1977, They exceeded petroleu revenues each yer before 1976 (except in fiscal year 197, the year of the Prudhoe Bay lease sale); but now, of the two sources, petroleu provides a larger percentage of revenues to the general fund. Generally, the past growth of these nonpetroleu revenues has traced a soothly rising path that roughly parallels the rising level of personal incoe in the state, which is the ajor source of these revenues. Anticipating the future level of these revenues is easier than projecting future levels of petroleu revenues because of the close relationship between nonpetroleu revenues and personal incoe. The largest coponent of the non petroleu revenues, for exaple, is the personal incoe tax, which is directly related to personal incoe. Thus, th3 level of future nonpetroleu revenues (shown in Figure 2), which increases steadily, reflects steadily rising personal incoes in Alaska. Earnings on Fund Balances This category consists of interest and other earnings on balances in the general and peranent funds. n the early years after statehood, this was a very sall source of revenues. n 1965, 1.5 percent of revenues cae fro earnings of the general fund. This percentage increased significantly when the general fund was augented by the Prudhoe Bay lease sale, rising to 3.4 percent of revenues in n future years, earnings on fund balances will becoe a uch ore iportant source of revenue as both the peranent fund and the general fund grow fro the receipt of petroleu revenues in excess of current expenditure requireents. t is possible that by 199, 28 percent of revenues could derive fro fund earnings. Figure 2 shows the pattern of these revenues over tie. They increase as fund balances are built up fro petroleu revenue receipts. After petroleu revenues peak and begin to decline, fund earnings continue to grow for 7 additional years. They then begin to decline as withdrawals fro the fund balances exceed contributions. Federal Grants-in-Aid During the period iediately after statehood, federal grants-in-aid typically accounted for over 5 percent of state revenues. Although the percentage has declined over the years, it is still considerable; in 1977, federal funds accounted for 2.7 percent of general fund revenues. However, the doinant position that federql aid occupied in the coposition of revenues in the early years has been partially taken over by petroleu rev nues, which have eerg3d as the priary revenue source. Federal grants will continue to grow slowly as state population increases. Presently, Alaska receives ore federal dollars per capita than any other state. This is partially explained by (1) the sall population, (2) the high cost of living, and (3) the federal progras intended to benefit Alaska's Native population. However, as the state grows, these factors that set Alaska apart fro the rest of the nation will becoe less iportant. Tot a Revenues Total revenues, as shown in Figure 2, will rise and fall in response to changes in petroleu revenues, and the post-1986 decline in total revenues will be a direct result of the decline in petroleu revenues. The increases in nonpetroleu revenues, federal transfers, and fund earnings will not be sufficient to aintain the previous levels of total revenues as the petroleu coponent declines. Thus, if the state chooses to spend revenues as it receives the, expenditures-and with the overall econoic activity-will follow the cyclical pattern of petroleu revenues, with a period of large expenditures followed by a long period of substantial cutbacks. CAN THE LEVEL OF STATE SERVCES NCREASE N THE FUTURE? Case 1: Moderate Growth in Expenditures By cobining revenue projections with expenditure behavior assuptions, one can siulate long-run growth patterns of state expenditures and exaine the iplications of the results. 3 n this case, total state governent operating expenditures are assued to continue to increase at a rate of 15 percent annually. Since the rates of population and price increase are accounted for within the siulations, this represents a 4.3-percent annual increase in the level of real services per capita. Because petroleu revenues will increase in future years, it is possible that state spending will grow in response to these increases, just as state spending grew in response to the revenues derived fro the Prudhoe Bay lease sale. This siulation however, assues that such a response does not occur, since the 15-percent growth rate is slower than the rate observed over any period since statehood. n addition to assuing an increase in the level of state governent services, this siulation assues substantial growth in the basic sectors of the econoy including ining and petroleu, 3These siulations eploy the Man in-the-arctic (MAP) econoetric odel of the Alaskan econoy, developed by the nstitute of Social and Econoic Research under a grant fro the National Science Foundation.

10 PAGE 1 UNVERSTY OF ALASKA, NSTTUTE OF SOCAL AND ECONOMC RESEARCH 9 8 PERMANENT FUND 1 GENERAL FUND BALANCE YEAR -1, -2, 25, ' Figure 4. State Fiscal Pattern if Operating Expenditures Grow 15 Percent Annually. (1977 Dollars) anufacturing, and agriculture-forestry-fishery. This growth would generate substantial revenues through incoe taxes and other revenues related to incoe and population. The level of petroleu revenues would be the sae as assued in the previous section, with 3 percent of petroleu royalties and bonuses going into the peranent fund; here they would be invested conservatively in high-quality securities. All other excess revenues in the general fund would also be invested in high-grade securities until needed. Figure 4 reveals that siulating with these assuptions, the level of state governent services would continue to expand only until n that year, the general fund would be eliinated. This would occur only 5 years after the peranent fund and the general fund peak in When the general fund balance is eliinated, state governent ust turn to alternative sources of revenue to support further growth. One such source would be the peranent fund. However, in only 1 year, the $3.4 billion which would have accuulated in the fund would be eliinated. For descriptive purposes, the siulation is allowed to continue by letting the general fund assue a negative value. The negative value corresponds to the revenues needed fro ilew sources to sustain the desired pattern of growth. n reality, a situation in which the general fund becae negative could, of course, not exist. The diagra in Figure 4 clearly shows what happens in this case. Expenditures continue to

11 UNVERSTY OF ALAS<A, NSTTUTE OF SOCAL AND ECONOMC RESEARCH PAGE 11 9 r , 8 PERMANENT FUND + GENERAL FUND BALANCE "' : ::5 _, :;; " "- "' 2 :J _, YEARS , 2 Figure 5. State Fiscal Pattern if Operating Expenditures Grow 15 Percent Annually and Petroleu Revenues are Large, (1977 Dollars) 2, ' increase without regard to projected revenues, and revenues, because of their large Prudhoe Bay petroleu coponent, decline beginning in The general fund, which is augented by excess petroleu revenues in the early 198s, is rapidly drawn down in the late 198s to sustain continued growth. Thus, a 15-percent annual growth rate for state expenditures is not feasible, given current expected levels of petroleu revenues. Nor does a ore optiistic set of assuptions regarding petroleu revenues change the basic result. Figure 5 shows that assuing a scenario which results in approxiately $2 billion in additional petroleu revenues between 198 and 2 (because of a higher level of discoveries and higher energy prices) siply postpones the tie when the general and peranent funds would be eliinated. 4 At the 15-percent annual rate of growth, the cobined balance.in the peranent and general funds would peak in 199, but 6 years later, the balances would be eliinated; by 2, there would be a deficit twice the size of general fund expenditures. Case 2. Slow Growth in Expenditures. A second case of interest is to allow state expenditures to increase annually at 1 percent in excess of increases in population and prices. This 4This petroleu revenue scenario is based upon a recent unpublished Departent of Revenue projection.

12 PAGE 12 UNVERSTY OF ALASKA, NSTTUTE OF SOCAL AND ECONOMC RESEARCH 9 15, 14, 12, " <( 8 6 c PERMANENT FUND+ GENERAL FUND BALANCE 1, 2 :J ;; JJ j i' 198 ' ::.f.neral FUND lijjirf NON PETROLEUM REVENUES f. ;.f. YEAR >99 2 Figure 6. State Fiscal Pattern if Operating Expenditures Grow 1 Percent Annually Net of Price and Population ncrease. (1977 Dollars) would allow for a very sall annual increase in governent services on a per capita basis; however, it would be uch slower growth than has taken place in the past, because. now, unlike the trend since statehood, the ratio of expenditures to personal incoe would be declining. This would also differ fro the experience in other states, where expenditure growth has generally been at least proportional to incoe growth. Figure 6 shows wlnat happens in this case. By targeting expenditures to increase by only 1 percent annually in real ters, the state would be able to aintain a positive balance in both the general fund and the peranent fund throughout the period analyzed. Slower growth of state governent would reduce the overall growth rate of the econoy and this would slow the rate of growth of nonpetroleu revenues. The general fund balance would grow uch higher and for a longer tie than if expenditures were ascu&d to grow at 15 percent annually. ts subsequent decline would be slower, and in 2, the level of the fund would be seven ties the level of general fund expenditures. (n 1969, iediately after the Prudhoe Bay lease sale, the balance in the general fund was six ties general fund expenditures.) This large terinal balance in the fund suggests that the state could support a 1-percent annual increase in the level of state services for ore than 2 years. Beyond 2, it is not clear for how uch longer the 1-percent growth rate could be sustained. The large earnings generated by the general fund balance would begin to decline, and nonpetroleu revenues would still be uch less than expenditures. Could general fund earnings continue to support the growth in state expenditures long enough to allow nonpetroleu revenues to catch up with' state expenditures?

13 UNVERSTY OF ALASKA, NSTTUTE OF SOCAL AND ECONOMC RESEARCH PAGE 13 n the final year of this siulation, non petroleu revenues and earnings fro the general fund and the peranent fund would pay for about 1 percent of total expenditures. n subsequent years, however, withdrawals fro the principal of the general fund would occur, because even though expenditures would be growing very slowly, they would grow ore rapidly than revenues. The gap between nonpetroleu revenues and expenditures would thus actually be wider at the end of the period than it was in 198. Nonpetroleu sources would finance 6 percent of expenditures in 198 and only 57 percent in 2. Case 3. Growth in State Expenditures that is Proportional to Personal ncoe. Figure 7 shows the case of a soewhat ore rapid growth rate in state services, which would aintain a constant proportion of state expenditures to personal incoe over tie. Such a growth rate is clearly not feasible in the long run, however, given the revenue assuptions used here. Not only would the ore rapid rate of increase in state services put pressure directly on state governent's financial resources, but the growth in state spending would cause ore rapid population growth resulting fro in-igration. This would put additional pressure on the state's liited financial resources, because the additional population would contribute only to an increase in nonpetroleu revenues. As a result, the cobined peranent and general fund balances, which would grow continuously to $1.3 billion by 1991, would precipitously fall to $3. billion by 2. Also, because of the ore rapid rate of 1,.-----= PERMANENT FUND+ GENERAL FUND BALANCE "' cc :3 -' Cl... :;; 6 Cl "' 2 Q...J 4 -' YEAR Figure 7. State Fiscal Pattern if Operating Expenditures Grow at Sae Rate as Personal ncoe. (1977 Dollars)

14 PAGE 14 UNVERSTY OF ALASKA, NSTTUTE OF SOCAL AND ECONOMC RESEARCH expenditure growth in this case, the state would ake no progress toward independence fro petroleu revenues. n 2, 4.8 percent of expenditures would be financed fro nonpetroleu revenues, about 1 percent fro earnings on the funds, 4.5 percent fro petroleu revenues, 15.5 percent fro federal grants-in-aid, and the reaining 29.2 percent fro the principal of the general fund. t is clear that in a few years the general fund balance would be eliinated, and at that tie the substantial state operating deficits would result in general-fund deficits. THE PERMANENT FUND The peranent fund has been established to prevent the rapid dissipation of the state's petroleu revenues. t is presently set up to receive 25 to 3 percent of petroleu royalty and bonus revenues. The peranent fund balance can be allowed to increase through the reinvestent of earnings in early years. Subsequently, the earnings of the fund could be annually transferred to the general fund and used to sustain the level of operating expenditures. Use of the fund in this way would arginally contribute to the state's ability to sustain any given level of governent services but would not provide the necessary revenues to significantly alter the pattern developed in the siulations described above. The proble with such an approach is that when petroleu revenues begin to decline, growth of the fund will also taper off. When additions in the for of petroleu revenues are no longer being ade, further additions will consist only of earnings. n order to provide an annual contribution to the general fund which is constant in real per capita ters, the sustained earnings of the fund ust increase faster than the growth in population and in the price level. t is unlikely that earnings can grow this rapidly, so they will provide a declining proportion of the revenues necessary to aintain a constant level of governent services. Figure 8 illustrates the relation between the sizes of the peranent and general funds, assuing a 3Dpercent peranent fund contribution rate and the sae expenditure behavior as described in Case 3 above. The peranent fund growth is rapid in early years but levels off about 199. Without reinvestent of earnings, the real value of the fund will then begin to decline as the rate of inflation exceeds the rate of new additions to the fund. n 2, it is less in value than the operating budget for that year. The general fund grows uch ore rapidly than the peranent fund in the 198s. At its peak, it contains about $8 billion (1977 dollars), which is four ties the balance in the peranent fund. n succeeding years, the general fund balance is drawn upon heavily to finance state operating expenditures and is essentially eliinated by the year 2. The nature of the peranent fund does not allow for withdrawals when fund balances are needed to aintain state operating expenditures. The advantage of the peranent fund is that it does channel a considerable aount of revenues away fro the current spending strea. The general fund conversely allows withdrawals when they are needed to pay for operating expenditures but does not shelter revenues fro the current spending strea when large balances are being built up. Clearly, the potential growth of the general fund balance to $8 billion (1977 dollars) in 1 years and subsequent rapid depletion requires that easures be taken to ensure the proper investent of the funds. Measures are also required to shield the large balance fro the teptation to spend the balance preaturely. At a later tie, as shown in all three of the previous siulations, the balance will be called upon to eet projected operating expenditures. ncreasing the contribution rate to the peranent fund would be one way of insulating soe state revenues fro spending pressure. This option would have two advantages. First, it would shield a larger portion of the projected general fund balance fro the teptation to increase the operating budget when revenues are increasing rapidly. Second, it would also potentially provide larger fund earnings in later years which could be contributed to the general fund. As indicated above, however, it is probable that the fund earnings would be decreasing in real per capita ters as price and population increases erode its value over tie. The principal disadvantage of a higher peranent fund contribution rate would be the inaccessibility of these additional revenues when they ight becoe necessary to aintain a desired level of state services or a sooth pattern of state spending. n addition, the general fund balance could generate earnings coparable to the peranent fund if the state adopted an investent policy for the general fund balance which was predicated upon longer-ter investents. Although the peranent fund provides a potent constraint against state spending, it cannot, in its capacity as a savings account, eliinate the situation caused by the cyclical nature of petroleu revenues. t can play a significant role in the state's long-ter fiscal health, but only insofar as other state fiscal policies aied at soothing out the state's long-ter expenditure pattern are concoitantly initiated.

15 UNVERSTY OF ALASKA, NSTTUTE OF SOCAL AND ECONOMC RESEARCH PAGE 15 Soe of these policies are exained in the next section. OPTONS FOR THE FUTURE The siulations presented above are not predications of what will happen in the future, rather they are projections of the future that are designed to be a part of an ongoing fiscal planning process. As conditions change and as the assuptions used in the odels are odified or the odels theselves altered, the projected pattern of the state's response will 11lso change. Notwithstanding the conditions iposed on these projections, one constant finding persists in all siulations run to date and that is, continued growth of state services depends heavily <t "' -' -'... '" u. "' z :J -' upon growth in petroleu revenues. The state cannot copletely eliinate its dependence on petroleu revenues siply because a significant portion of the activity in the private econoy is the direct result of petroleu developent. A reduction of petroleu activity would slow econoic growth and deands for governent services would decline. t is clear,!jowever,,that serious thought ust be given even today to the eventual transition of the state governent fro priary dependence on petroleu revenues. The basic dynaics of the proble of transition can be siply stated and are illustrated in Figure 9. The present level of state expenditures is heavily influenced by the availability of petroleu revenues.,, --- /' -,,, '' "-, / GENERAL FUND BALANCE \ 8 r , , ,t' / /..-"'.?---' \ ' \ \ \ \ \ \ \ / \ \ \ \ \ PERMANENT FUND BALANCE // ', \ / ;&.,/ /"'"' \,., "' YEAR Figure 8. Projected Pattern of Balance in the Peranent and General Funds (Assuing 3 Percent Contribution Rate to the Peranent Fund) ' ' ' ' ',..J 2

16 PAGE 16 UNVERSTY OF ALAS(A, NSTTUTE OF SOCAL AND ECONOMC RESEARCH T / "' a: :'3..J T 1 = n this case nonpetroleu revenues grow fast enough to qual state expenditures before the 'cushio: is gone. T = 2 1 n this case the 'cushion' is eliinated befdre nonpetroleu revenues can support the preva1lg level of state expenditures. At T 2 expenditures ust fall. PRESENT FUTURE Figure 9. Possible Growth Paths for State Services. These revenues allow state spending to be at a uch higher level than would be the case if nonpetroleu revenues were paying for all services. Over tie, the state econoy will grow, and this growth will cause revenues derived fro nonpetroleu sources to increase. For exaple, personal incoe tax receipts will grow as personal incoe increases. This source of revenue will grow at approxiately 8 to 1 percent annually. Siultaneously, this econoic growth will generate a deand for state services. The growth rate of these services will be deterined by growth in the size of the budget. At soe tie in the future, non petroleu revenues will have to pay a uch larger percentage of the cost of state governent than they do presently', This will becoe necessary when the decline in petroleu production on state-owned and private lands leads to a decline in petroleu revenues. When that occurs, the earnings and principal of the iportant state funds-the peranent and general revenue funds-will be the only "cushion" filling the gap between expenditures and nonpetroleu revenues and preventing expenditures fro iediately falling to the level of nonpetroleu revenues. When the cushion is exhausted, state expenditures ust decline to the level of nonpetroleu revenues. Two cases are shown in Figure 9. n the first, state expenditure growth is slower than that of nonpetroleu revenues. At tie "T 1 " nonpetroleu revenues equal total expenditures, and state governent is independent of both petroleu

17 UNVERSTY OF ALAS(A, NSTTUTE OF SOCAL AND ECONOMC RESEARCH PAGE 17 revenues and earnings fro the general and peranent funds. This is a feasible situation if, at "T1," the general fund is not in a deficit position. f tho fund is negative at "T 1," the level of state services depicted is not feasible. n the second case, the rate of growth of state expenditures exceeds that of nonpetroleu revenues. As a result, the difference between state expenditures and nonpetroleu revenues increases over tie. As before, this difference is ade up by petroleu revenues and the cushion provided by the peranent and general funds. The size of the cushion is liited and cannot expand indefinitely so that at soe point such as "T 2," it is eliinated, and expenditures ust abr'uptly decline to the level of nonpetroleu revenues. A strategy for dealing with the proble of transition fro petroleu revenue dependence will consist of any coponents since there exists no single solution. The peranent fund is an iportant coponent. Several other possible coponents of a strategy are briefly exained below. 1. Do nothing. A continuation of past spending behavior would result in a rapid increase in state expenditures when revenues increase and substantial resistance to expenditure reductions when revenues decline. The period after the Prudhoe Bay lease sale is indicative of this behavior. f state governent followed this pattern, it could face the necessity of aking a substantial absolute reduction in the level of state services in a decade. This strategy iplies that it is preferable to provide a higher level of services in the present in exchange for a significant reduction in the level of services at soe future tie. 2. ncrease petroleu revenues. Because of additional discoveries on state or private lands, higher tax rates and royalties, or higher wellhead values, petroleu revenues received by the state ay exceed present expectations. Analysis indicates that in order to ake a significant difference, petroleu revenues would need to be larger by any billions of dollars. n any event, the essential cyclical pattern of the revenues would occur regardless of their size. An increase in petroleu revenues could either reduce or intensify the proble of the gap between expenditures and nonpetroleu revenues. f the additional revenues were teporarily insulated fro the spending strea, they would provide additional tie for the econoy to wean itself fro dependence on petroleu revenues. f, on the other hand, the additional revenues resulted in an iediate expansion of the budget, then dependence on petroleu revenues would actually increase. 3. ncrease nonpetroleu revenues. Additional sources of revenue which have not been anticipated in this study will probably becoe available to the state in future years. However, because of the agnitude of petroleu revenues, it sees unlikely that alternative sources would be able to generate revenues sufficient to replace those supplied by petroleu. For exaple, to replace the $79 illion of petroleu revenues expected in 1979,5 one of the following would have to occur: The state personal incoe tax would have to be increased to nearly five ties its present level The coercial fish taxes would need to produce over eighty ties their predicted revenues. At a royalty of $.2 per ton, 3,545 illion tons of Alaskan coal would need to be produced. (n 1975, total U.S. production of bitull"inous and lignite coal was 64 illion tons.) 4. Reduce the growth rate of state services. Reducing the growth rate of state expenditures by even 1 percent would increase the lifetie of the peranent fund and general fund cushion. However, there are liits to how uch the rate of growth in the budget can be reduced, although it is not known what those liits are for Alaska. n ost states, expenditures grow at about the sae rate as personal incoe, and for political reasons, slower growth ay be very difficult to achieve, particularly during a period in which the state ay have several billion dollars of surplus revenue. 5. Establish a target growth rate for state expenditures based upon long-run revenue projections. The establishent of a realistic target rate of expenditures growth that is independent of the cyclical fluctuations inherent in petroleu revenue receipts would serve two purposes. t would reduce the overall growth rate and thus postpone the tie when the fund cushion would be depleted. Second, it would reduce the tendency for state expenditures to increase in a discontinuous fashion when petroleu revenues increase. 6. Stiulate investent in Alaska. The peranent fund and other resources can be used to accelerate the rate of investent in Alaska. This could increase tax revenues fro nonpetroleu sources. New investents would increase the deand 5 Alaska Departent of Revenue, Revenue Sources FY This figure includes the production and property taxes and rents and royalties accruing to the general, peranent, and renewable resources developent funds.

18 PAGE18 UNVERSTY OF ALASKA, NSTTUTE OF SOCAL AND ECONOMC RESEARCH for state services because of induced population growth, at the sae tie that they would broaden the econoic base of the state. Accelerated investent is, thus, a two-edged sword-increasing financial resources while increasing deands on those resources. Because of the state's large dependence upon petroleu revenues for the financing of services, it is difficult for new investents to narrow the gap between expenditures and revenues. t is ore likely that population additions would increase pressure on the liited resources of the general fund. The dependence of state expenditures on petroleu revenues eans that a new basic industry would be required to provide revenues on the sae order of agnitude per eployee as the petroleu industry to prevent a negative ipact on the general fund. 6 n addition, any new basic activity, such as a petrocheical refinery, would result in an increase in econoic activity in the support sectors of the econoy. To avoid a negative net fiscal ipact, revenues fro not only the basic activity but also fro the support services activity ust exceed the costs of new governent services. These points are illustrated in Figure 1, which shows state revenues per eployee in the petroleu industry, in all other industries, and the average for all Alaskan industries as well. t is extreely unlikely that new industry could atch the revenues generated by petroleu, but it could directly provide ore revenue per eployee than the statewide average. Basic industry growth would engender support sector growth, and support sector revenue potential is coparable to that of the nonpetroleu sector. Since the eployent resulting fro this growth would partially coe fro outside the state, governent services would need to expand to provide for this additional population. f per capita services were to reain constant, a negative net fiscal ipact on the general fund would result. Net fiscal ipact is not the only criterion by which the state should easure a potential 6To eliinate the gap expected in 1979 between expenditures and nonpetroleu revenues would require the cobined corporate tax receipts collected in 1975 fro 2 states-with no increase in state services tto support the level of econoic activity that iplies. Those states, with 1975 corporate tax receipts of $545 illion, were Alaska, Arizona, Arkansas, Delaware, Hawaii, daho, Maine, Mississippi, Missouri, Montana, Nebraska, New Hapshire, New Mexico, North Dakota, Oklahoa, Rhode sland, South Dakota, Utah, Veront, and West Virginia. U.S. Departent of Coerce, Bureau of the Census, State Tax Collections in 1975, p. 7. investent using the peranent fund or other state resources. Within this fraework, however, it is difficult to see how state investent in new industry can close the fiscal gap which petroleu revenues have opened, both because of the size of the gap and the fact that industrial expansion also leads to expansion of governent services. 7. Moderate the rate of population increase. Population in Alaska will continue to grow not only because of natural increase but also because of in-igration. The availability of jobs and the high level of personal incoe in Alaska are powerful factors drawing new people into the state. This population growth puts an additional burden on the state's liited financial resources at the sae tie that the growth helps to broaden the base of the econoy. One way to iniize this financial burden is to axiize the use of the existing labor force in Alaskan jobs rather than relying on additions to the labor supply fro outside Alaska. Since the historic uneployent rate for the state has reained at about 9 percent independent of the growth of the Alaskan econoy, a potential exists to use Alaska's uneployed huan resources. At the sae tie, this constant level indicates that the proble of uneployent is not solved siply by the creation of new jobs. New jobs increase the labor force by increasing the nuber of people who coe into the state looking for jobs. A reduction of the uneployent rate requires that the nuber of jobs increase ore rapidly than the nuber of people looking for work. CONCLUSON Alaska faces a period of unprecedented growth in state revenues resulting fro the developent of its significant petroleu resources. This growth ay last only a decade before a decline in petroleu revenues will require that state expenditures be financed increasingly fro nonpetroleu sources. n order to effectively respond to the inevitable situation when transition fro dependence on petroleu revenues ust occur, long-range fiscal planning ust begin iediately. t is encouraging that a step in that direction was taken by the legislature when it attepted in the ost recent legislative session to establish a target expenditure growth rate. The process of planning for the transition will be an evolutionary one involving a continuous review of all options available to the state. A ajor purpose of this Review is to help provide direction for that process.