Fiscal Policy Caucus. Facts and Findings for a Long-Range Fiscal Plan for Alaska

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1 Fiscal Policy Caucus Facts and Findings for a Long-Range Fiscal Plan for Alaska December 1,

2 The Vision Statement The Plan Alaska will provide quality, cost-effective public services funded by a system of revenues that is reliable, fair and diverse. The Gap Status Quo / / Fiscal Year: / / ($ Millions) General Fund Revenues 1,544 1,445 1,519 1,424 General Fund Expenses 2,409 2,523 2,523 2,523 Fiscal Gap (865) (1,078) (1,005) (1,099) CBR Budget Reserve Fund Year-End Balance (used to fill fiscal gap) Earnings Reserve Account Year-End Balance (included in tot. PF below) 2,399 1, (Projected to be gone by ) 2,125 2,468 2,918?? Permanent Fund Year-end Market Value 24,168 25,374 26,769?? Permanent Fund Dividend Amount $1, $1, $1,430.00?? The Purpose The Alaska Legislature must provide the framework for placing Alaska s financial house in order with a longterm approach to funding the costs of public services. The Problem The State of Alaska provides a wide range of services to a diverse population spread over a logistically complex area. Providing these services currently costs more than the state is receiving in recurring revenue. The state is spending more than it is receiving in all revenues. This means the savings which had been placed in a Constitutional Budget Reserve (CBR) is rapidly being depleted. Current projections show that fund almost completely eliminated in two fiscal years if nothing is done. The CBR currently has about $2.8 billion. The projected deficit of revenues minus expenses is projected to be about $865 million as of June 30, (See the chart above for further projections of the deficit). A long-term plan for fiscal integrity is needed to provide a stable business climate and to ensure the citizens of necessary services. However, before long-term considerations can be implemented, there is an immediate, emergency need to increase revenues and reduce spending in the least harmful way to the economy and the residents. If a satisfactory combination of reduced spending and increased revenues is not implemented in this legislature, the Permanent Fund Dividends, and eventually the Fund itself will be used for essential public services and the popular PFD program will be the loser! 2

3 Holding back the Tide Various attempts by individuals, groups, legislators, the executive and the legislature have been made in the last 8 or more years to fix the problem of expenses that were greater than income or revenues. Spending has been held nearly constant in spite of increased population and service needs as well as inflation in accord with the legislative leadership s Five-year Plan. As a result, since 1996, Alaska has achieved the only real cut in general fund spending - a cut of more than 5% - while other states have increased spending by an average 22%. This, and past failures to fund for the future, has resulted in deteriorating state assets, and large capital costs confronting the state, along with a potential reduction in services. Some reinvestment into the infrastructure of the state must be made even in these declining revenue times to avoid further loss of value and detriment to the economy. Further spending reductions must be made, but in a way that does not put the entire state s economy into a tailspin. Prior Efforts There have been other plans to resolve these fiscal issues. One such plan would have only used the interest earned from revenue made available from non-renewable resources. Known as The Cremo Plan, a forward-thinking Alaskan tried for years to convince the Legislature to stop paying its expenses through the liquidation of its assets. Mr. Roger Cremo crusaded to change our patterns so that Alaska would treat the sale proceeds of our natural resources as capital (similar to the Permanent Fund), only distributing its earnings for sustaining public services and never the principle. Instead, Alaska treats the royalties and taxes from oil as income, spending every dime immediately. Thus resulting in the volatility and economic instability we face today! Had politicians reversed this practice years ago, the revenue stream would be stable. This Planning Effort After the failure of the ballot measure to use Permanent Fund earnings in 1999, most legislators continued to hold the line on spending and hoped for a windfall of revenue from new developments or discoveries. In fact, some small oil discoveries and increased life have kept the reductions of oil royalties much smaller than originally projected. Just as predicted however, oil and gas royalties are going down, overall production is decreasing and the price has fluctuated from $8 to $32/barrel. Large new discoveries in the Petroleum Reserve, or if ANWR s Coastal Plain was opened, are too far in the future to save the state from this fiscal problem. So is the return from any natural gas pipeline or such large planned economic development. Formation of the Fiscal Policy Caucus Recognizing these important facts and realities, many newly elected representatives and senators along with others from the public and business sectors felt the need to renew the idea of engaging in long term financial planning for the state. Some ran for election on that premise and feel obligated to pursue such a plan. That incentive, coupled with the continued concern for reduced revenues, led to the formation of the Legislative Fiscal Policy Caucus. Last legislative session, the leadership of the House charged the Caucus with developing a plan that could be placed in front of the legislature for implementation to create such a long-term fiscal plan. 3

4 Eleven public forums sponsored by individual Fiscal Policy Caucus members have been held throughout the state during the interim to explain the problem to the public and to solicit their ideas for solutions. Also, different groups, e.g., Alaskans United, Commonwealth North, and the Alaska Humanities Forum in their Alaska 20/20 Series, have provided state budget oriented educational materials, planning workshops, and efforts to draft solutions to the shortage of funds in Alaska s budget. All of these efforts were considered in this planning retreat which was the culmination of the previous events. The Retreat The Caucus used a facilitated process to review individual legislator s expectations, baseline data including products of the public forums, previously introduced legislation, public interest group products, and budget projections. The twenty-four committed legislators in the Caucus met in a non-partisan, open, public work session to use that information to create a vision and the values, attributes, or components of a workable plan to get the state s fiscal house in order for the future. This is that workable plan. Key Components These key components; the Essential Elements, the Caucus Goals, Identification of new Revenue Measures as well as Spending Constraints, and the Steps for Implementation for a Long-Term Fiscal Plan are for the entire period of the Plan. Although long-term in nature, many will be implemented as rapidly as possible. The overall purpose is to establish a stable, growing economy for Alaska, which provides fiscal security for the long term, while meeting the immediate needs of the citizenry. 1. Protect the Permanent Fund Principal 2. Retain the CBR at a minimum of $1.5 billion 3. Promote Fiscal Restraint/Encourage Governmental Efficiencies 4. Diversify and Identify New Revenue Sources 5. Maintain informed, open, honest fiscal policy discussions 6. Recognize effect/impact of unfunded mandates 7. Identify and Respond to Alaska s Needs 8. Fair sharing of responsibility amongst all 9. Ascertain Long Term Capital Financing/Acknowledgement of Unmet Needs 10. Spend only Earnings from future non-recurring revenues 11. Promote responsible resource management Goals 1. Ensure sustainable long-term economic growth 2. Ensure Alaska s competitiveness 3. Actions to have the least harm to the economy 4. Business and Industry Incentives for development 5. Seek Investment opportunities in under-developed regions of the state 6. Connect Economic growth and development with state revenues to meet increased expenses 7. Recognize unique characteristics and economic opportunities 8. Protect and enhance existing infrastructure 9. Develop a system of quality education, safety and other public services 4

5 Spending Constraints One way to effect the degree of the immediate gap is to further reduce the costs of public services. The following is a list of ideas offered by individual members of the Caucus. Although there was no consensus on endorsing any method in particular, it was acknowledged that these ideas should be explored further, as indeed many of these methods for reducing spending are ongoing efforts in the Legislature. Cap or Restraint on Spending in some form Efficiency and Consolidations/Eliminate duplications Cut Administration/Management in the three branches of government by 10% Drug and Alcohol Rehabilitation [short term increase to avoid long term costs] Missions & Measures Performance based budgeting Reduce pork pet projects for legislator s districts Procurement Consolidation where appropriate Limit length of session, limit staff, limit travel of legislators Unicameral legislature Biennial budgeting Regulation reform & streamlining development Establish spending priorities Restructure all mid-management [too much of it now] Restructure Education administration [state versus local responsibility, and delivery] Eliminate marginal services What services should be performed where and by whom what is bottom line? Consolidate School Districts Revamp & Upgrade technology Revenue Increases Regardless of the success of any of the possible cost reductions, it is recognized that there is a greater need for significant additional revenues. This is especially true, since there is no way to cut enough expenses to meet the immediate budget gap. See Status Quo graph, page 2. The Plan adopted by our Caucus is designed to provide enough revenue to keep a healthy CBR for the future, and to maintain the current level of services in the long term. Therefore, the following proposed conceptual options for obtaining necessary revenues are a starting point to be submitted with this Fiscal Plan to the legislature in January, The following page contains the Fiscal Policy Caucus recommendations on potential sources of increased revenue. 5

6 Fiscal Policy Caucus Recommended Measures Spending Constraints (See Page 5) Possible New Income Sources Current Legislation Detail Annual Approx. Calculations Recommended Cap Permanent Fund Dividend (Change Formula) $1, $182 FY 03 Personal Income Tax (w/ Triggers related to price/production of HB 199 (HB 10) 3% Fed. Adj. Gross Income $270 1% of taxable income = Approx. $90 million per year FY 03 State Sales Tax HB 233 2% $200 1% = $100 million; 1% = $70 million excl. food & medical FY 03 Earnings Reserve Account Surplus (after Dividend and Inflation Proofing Disbursement) HJR 15/SJR 13 HB 35 Transfer % to GF $127 $175 to $300 million per year FY 03 Alcohol Tax Increase HB per drink $15 5 cents per drink = $15 million per year FY 03 Motor Fuel Tax Increase None.05 per gallon $15 5 cents per gallon = $15 million per year FY 03 Cruise Ship Passenger Tax None $25 per passenger $17 $25 per passenger = $17 million per year FY 03 Oil and Gas Production Tax In- None 20% $100 10% increase = $50 million per year FY 03 Education Tax on Employment HB229 Yes $38 $100 per person = $38 million FY 03 Change in Permanent Fund Deposits HB 3 Yes $33 $22.5 million to $35.5 million per year FY 03 6

7 Implementation There is general agreement that the collective options are only a starting point, and this is a conceptual plan only. Also, the consensus of the Caucus is that simply criticizing this Plan or a particular revenue option is not acceptable; rather, alternatives to achieve a balanced budget are needed. The Caucus recommends an open public discussion of this Plan and recognizes the role of the legislative process, committee hearings and the like and has no intention of infringing on that practice. Steps Implementation will consist of public and legislative review of this draft Plan. The Plan will be finalized and adopted by the Legislature after public review and modification. The public and legislators will use the Plan Components to test various legislative proposals and amendments throughout this and future legislative sessions. Legislation to implement various options will be duly considered by the entire legislature in the regular order of business. The emergency nature of the fiscal crisis requires action as rapidly as possible and it is expected that will happen. The long term goal is to keep an emergency reserve of $1.5 billion in the CBR, even though it will likely drop below that by FY 2003 or FY The CBR could likely fall to near zero before economic stimulates and diversity can produce new revenues such as ANWR or the gas pipeline to build it back up. Shrinking the Gap - If FPC Measures Implemented FY ($ Millions) General Fund Revenues 1,544 1,800 2,512 2,428 2,354 2,316 2,283 General Fund Expenses 2,409 2,571 2,623 2,675 2,729 2,783 2,839 Fiscal Gap (865) (771) (110) (247) (374) (468) (555) Budget Reserve Fund Year-end Balance (savings used to fill fiscal gap) 2,399 1,765 1,773 1,644 1,381 1, Permanent Fund Year-end Market Value (including Earnings Reserve) 24,168 25,209 25,981 26,713 27,420 28,116 28,801 Permanent Fund Dividend Amount $1, $1, $1, $1, $1, $1, $1,

8 Caucus Commitment The legislators in attendance accepted their obligation as elected leaders to solve the state s fiscal problems. Each member of the Caucus is committed to the success of this planning effort and in getting Alaska s financial house in order. Triggers The Caucus endorsed trigger mechanisms that would scale back new taxes and/or restore PFDs to the current formula if new revenues are developed. For example if both a gas pipeline and ANWR or comparable revenue generating development were to happen, taxes and use of Permanent Fund earnings would not be necessary or justified. Members of the Caucus Present: Representatives: Ethan Berkowitz Mike Chenault Sharon Cissna Harry Crawford Eric Croft (Fri) John Davies Hugh Fate Gretchen Guess Andrew Halcro Joe Hayes Bill Hudson Beth Kerttula Ken Lancaster Lesil McGuire (Sat) Kevin Meyer Carl Moses Lisa Murkowski Norm Rokeberg (Fri) Gary Stevens Drew Scalzi Peggy Wilson Senators: Alan Austerman Johnny Ellis (Fri) Kim Elton Ben Stevens 8

9 The Nature of the Problem Department of Revenue Synopsis Alaskans have lived off the strong cash flow from North Slope oil fields beginning in the late 1970s and through the start of the 1990s. The annual tax and royalty revenues paid the bills for the public services that people had come to expect and enjoy. Then, as oil production was in its downward slide by the early 1990s, Alaskans were able to enjoy the same services because we had the Budget Reserve Fund to pay the bills. Voters approved the Constitutional Budget Reserve fund in 1990 as a savings account for future oil and gas tax and royalty settlements. The state had accumulated a hefty number of disputed tax and royalty cases, and the legislature asked voters to amend the constitution to set up the fund to hold the anticipated settlements. The fund was established to cover fluctuating oil revenues, allowing the state to maintain public services in years of low prices. As expected, the reserve fund has received several large deposits of tax and royalty settlements. Since its start a decade ago, the account has received $5.5 billion, of which Alaska has spent $4 billion. The result is we continued to live off oil money in the 1990s we just did it differently. Instead of paying our bills from the cash of current year s taxes and royalties, we spent our account receivables (our IOUs) as we collected them. But all of the large tax and royalty cases have been settled, which means there are no more big deposits to replenish the reserve fund, which means we re running out of money and time, which means we have a problem. The reserve fund started Fiscal Year 2002 (July 1, 2001) with about $3 billion. Our assumptions include a small increase in oil production over the next few years and a gradual return to historic average prices for Alaska North Slope crude. (The average daily production from the North Slope in Fiscal 2001 was 990,000 barrels, the lowest since the pipeline went into full production.) No doubt Fiscal 2001 was a great year for oil prices, with North Slope crude averaging close to $28 a barrel the highest in 17 years. But everyone knows the pains of price volatility. It was just two years ago, in Fiscal 1999, when oil averaged about $12 a barrel. That s why the reserve fund is so important to Alaska. We need it as a cushion, a shock absorber in years of low prices. If we drain it to cover our lack of a fiscal plan, it will not be around to cover its original purpose of holding steady our budget for public services. The numbers tell the story of the state s reliance on oil revenues. In the 1980s, the state averaged about $3 billion a year in unrestricted revenue, of which $2.2 billion was from oil and gas. In the 1990s, the average revenues for a year dropped to $2.2 billion, of which $1.7 billion was oil and gas. In the first decade of the new century, we expect the average to fall even further, to $1.6 billion, with $1.2 billion of that from oil and gas. We just can t maintain public services for a growing population from a falling revenue source. In addition to fluctuating oil prices and lower production, a third factor contributes to the revenue decline. The Economic Limit Factor (ELF) is a multiplier of the state s production tax rate designed to collect less tax on smaller, marginal fields, while maintaining a higher rate on larger fields. All of the new discoveries are being taxed at a lower rate than the declining fields at Prudhoe Bay and Kuparuk. Every barrel of new oil is taxed at a lower rate than the old oil it replaces in the pipeline. Even if total production 9

10 holds steady, or increases a bit, production tax revenue to the state will continue to decline. Production from the National Petroleum Reserve-Alaska could reverse the decline in state revenues, as could a natural gas project or production from the Arctic National Wildlife Refuge. But any revenues from those possibilities are at least several years away. Without the reserve fund to fill the gap, choices would include drastic cuts in public services, dramatic increases in existing taxes, cutting back on the Permanent Fund dividends and/or spending Permanent Fund earnings. The Department of Revenue believes the state needs to maintain a reserve fund balance of about $1.5 billion to protect Alaskans from periods of low oil prices. The challenge before Alaskans is to put together a fiscal plan based on new revenues and wise spending before the budget reserve drops below a safe level. Department of Revenue, 9/01 10

11 Department of Revenue December 7, 2001 Release LOWER OIL PRICES WIDEN FISCAL GAP Return to average prices produces billion-dollar deficit in Fiscal Year 2003 The Department of Revenue projects North Slope oil prices will hover close to their historical average of around $18 a barrel after two years of higher-than-average prices. The price shift will add to the state's fiscal gap, with expected draws on the state savings account of $906 million in Fiscal 2002 and $1.13 billion in Fiscal 2003, said Revenue Commissioner Wilson Condon. "Despite higher production, the budget gap will grow regardless of what oil prices do," Condon said today as the department released its Fall 2001 Revenue Sources Book. "Our reliance on newer, more costly oil to replace the declining flow from our aging fields means less revenue for the state. Low oil prices only exacerbate the situation." Based on the department's oil price and production forecasts, and assuming a spending level needed to maintain existing services, the Constitutional Budget Reserve Fund will hit empty in July almost a full year sooner than forecast by the department last spring. The Budget Reserve Fund is at $2.8 billion this week, with an additional $100 million draw scheduled for next week. "Until Alaskans can agree on a fiscal plan, which must include new revenues, we will continue to drain the Budget Reserve Fund," Condon said. "Higher, or lower, oil prices could move the end date into 2005 or 2003, but, realistically, we know we're getting dangerously close to the end of the line." The department forecasts Alaska North Slope oil prices to average $20.55 for Fiscal Year 2002, which ends June 30. That's a drop of almost $2 a barrel from the Spring 2001 revenue forecast and almost $4 from the Fall 2000 forecast. "Although prices have been around the $17 range the past week, the year-to-date average is $22, and we believe the higher prices of the first six months we help keep the year-end average respectable," Condon said. Prices are expected to continue their downward trend, however, averaging $18.81 a barrel in Fiscal 2003 and then picking up a bit to $19.72 a barrel in Fiscal 2004 if the world economy recovers. Although the price forecast is down from previous estimates, North Slope production is expected to increase after falling to an average of 991,000 barrels a day in Fiscal the first time the flow has dropped below 1 million barrels a day since full production started 24 years ago. The department forecasts Fiscal 2002 production to average million barrels a day, building to million barrels in Fiscal 2003 and million barrels a day in Fiscal North Slope production is forecast to remain above 1.1 million barrels a day through Fiscal "Alpine and Northstar are primarily responsible for the production growth," Condon said. "The producers are to be commended for bringing the new fields online. We certainly hope for more new production to help reverse the overall decline in older fields on the slope." For more information, contact Deputy Commissioner Larry Persily at

12 MEMORANDUM DATE: January 8, 2002 Alaska Permanent Fund Corporation P.O. Box Juneau, AK Telephone (907) Facsimile (907) TO: FROM: SUBJECT: Representative Bill Hudson Jim Kelly Director of Communications "What would happen if the Permanent Fund's earnings reserve account (ERA) were called upon by the legislature to effectively replace the CBRF as the source for funding the budget gap when the CBRF runs out?" The Department of Revenue estimates that the CBRF will be depleted late in calendar 2004 and thus will be unavailable to fund the expected $1.099 billion budget gap in FY 05. Based on the APFC's current projections, the Fund's ERA most likely would be sufficient in FY 05 to fund the budget gap that year and pay dividends per current formula. However, there is a chance that the ERA itself could be depleted by that date in the event of continued negative investment returns between now and then. The full answer depends on whether the Board-proposed percent of market value (POMV) payout limitation has been placed in the constitution by the time the legislature needs to use the Permanent Fund for the state budget. If the constitutional amendment has been passed. The APFC s analysis of the constitutional amendment proposed under HJR 15/SJR 13 indicates that the Permanent Fund is likely to be able to produce earnings to support an annual payout of five percent of the five-year average market value of the Fund. That is estimated at from $1.2 billion to $1.4 billion per year in inflation-adjusted 2001 dollars. That payout would be for all purposes approved by the legislature, including the dividend and the general government budget. If you assume no change in the present dividend statute, which is based on realized income rather than market value, some $175 million to $300 million would be available each year for budget purposes other than the dividend. These estimated ranges are narrow because of the five-year smoothing built in to the payout proposal. If the constitutional amendment has not been passed, however, the amount available for the legislature to appropriate each year for all purposes would vary much more widely. Instead of a range of $1.2 to $1.4 billion, it could be as little as a few hundred million to well over $2 billion. To illustrate the real-life impact of volatility, consider the following numbers: A. Note the APFC s November projected June 30, 2002 balance in the realized ERA, after dividends and inflation-proofing: $1.9 billion. B. Note the annual swings in statutory net income over the past four years plus 2002 projected: 1998 $2.6 billion 1999 $ $ $ $1.2 12

13 C. Note the annual Net Change in the realized ERA (after dividends and inflation-proofing) for the same period: 1998 $1,282 million 1999 $1, $ $ $471 The first number (A), $1.9 billion, is the beginning size of the cushion in the realized ERA. When that is gone, or nearly gone, legislative appropriations for all purposes would be completely subject to the wide variability demonstrated by the set of numbers shown in (B). The (C) set of numbers shows what would have been left for funding the budget gap after paying dividends and inflation-proofing; it is obviously quite volatile. This volatility was not a problem in the past because the bull market added billions of dollars to the Fund s reserves and payments from the Fund were limited to dividends only. Now, a bear market is reducing Fund reserves and the legislature is considering increased payouts to help fund the budget gap. In this environment, it is essential to prudently manage the impact of volatility in investment returns. 13

14 Senator Dave Donley For Immediate Release: Oct. 22, 2001 Contact: Ron Irwin (907) Former Governor Jay Hammond Joins Other Alaskans to Sound Off on Long Range Fiscal Planning Before the Senate Finance Committee (ANCHORAGE) Former Governor Jay Hammond joined other Alaskans who braved the first big snow storm Saturday to file into the Legislative Information Offices in Anchorage and other area around the state to participate in the Senate Finance Committees public hearings on a new Long Range Fiscal Plan for Alaska. Sen. Dave Donley (R-Anchorage), who is the Co-Chairman of the Senate Finance Committee kept his promise to hold public hearings to find out what the people of Alaska felt should be done concerning the growing fiscal problem in the State. Donley felt it was important to give people an opportunity to speak their minds in front of the Senate Committee that the actual jurisdiction over fiscal issues. Donley hopes to narrow the fiscal gap, which is projected to top $500 million this year. He plans to do this by passing seven bills and two constitutional amendments, all with the aim of establishing a more streamlined, efficient and fiscally responsible government, while maintaining and improving state services. Donley says to handle the projected $500 million dollar fiscal gap the State needs action not just rhetoric. Donley's approach to the problem, involves a systematic step-by-step method, a plan that drew support from those in attendance Saturday, including Gov. Hammond. Hammond said he preferred Donley's step-by-step approach to responsible fiscal planning, rather than an all inclusive concept, like the 1999 plan (rejected by 84-percent of voters) that is still being pushed by some members of the Legislative Fiscal Policy Caucus. Hammond warned the committee that if they wanted the support of the public the government would need to address fiscal issues a piece at a time. In other words curb spending before talk about initiating taxes and explore tax revenue options before even considering touching the Permanent Fund. "The public does not feel they are listened too," Hammond said. "We can not look at using dividend dollars before tax dollars." Saturday however, the people were listened too. And the Senate Finance Committee heard them say don't look at tax dollars either if you don't first cut spending. 14

15 "We need a cap on government spending," said Linda Reynolds a Kenai voter. " We need to look at layers of bureaucracy and make cuts." Chuck Achberger of Anchorage took the need for fiscal responsibility up a notch by pointing fingers at the worst spender in the government. "The Governor's approach to spending is like a teenage kid with daddy's Visa Gold Card," Achberger said. "Before we introduce random acts of taxation, we must get spending under control." Thus was the sentiment of public testimony from Wrangell to Fairbanks. And Donley along with the Senate Finance Committee seemed poised to heed the advice given Saturday by concentrating first on controlling spending and making the Government work within its means. Arrangements can be made to interview Sen. Donley on this and other issues by calling his Anchorage office at All efforts will be made to accommodate individual deadlines. # # # 15

16 Fiscal plan: More than taxes, Fund raids By SEN. DAVE DONLEY Anchorage Daily News VOICE OF THE TIMES Saturday, May 5, 2001 Development of a long-range fiscal plan is one of the greatest challenges facing Alaska. But like most Alaskans, I do not believe the answer is simply passing new taxes or raiding the Permanent Fund. In my opinion, that is not a plan -- it is a recipe for fiscal disaster. We cannot tax or spend ourselves to economic self-sufficiency. We won't "balance the budget" by spending more money. Without meaningful restrictions on state spending, adding new revenues simply fuels the fire and encourages increased spending -- which will in turn create a larger fiscal gap. As co-chairman of the Senate Finance Committee, I believe the first two essential elements of any fiscal plan should be a strong constitutional spending limit and Constitutional Budget Reserve reform that encourages fiscal discipline. Such actions are a critical first step in developing a long-range fiscal plan for Alaska. Without an enforceable constitutional spending limit, simply tapping into the Permanent Fund or adding major new taxes as the governor has proposed will only make the problem worse. It's kind of like trying to put out a brush fire by drenching it with gasoline. With easy access to more money, there would be no incentive to curb state spending. Only by holding the line on government spending and renewing our efforts to improve government efficiency can Alaskans hope to break the economic boom and bust cycles that have plagued our past. As we continue to work toward a new fiscal plan, it is important to recognize the significant accomplishments of the just-completed -- while the Permanent Fund was protected, and increased to more than $26 billion. More importantly, Republicans held the line against $800 million in spending increases proposed by Democrats and Gov. Tony Knowles. The Republican majorities also successfully initiated major governmental reforms. Welfare reform, bureaucracy reduction, education funding reform, tougher criminal laws and solving prison overcrowding were all part of a comprehensive plan to improve Alaska's state government. And, while reducing general fund state spending, we increased funding for local schools and the University of Alaska. To encourage discussion about what the next step in a fiscal plan should be, earlier this year I wrote the commissioners of every state department asking for their ideas on ways to improve government efficiency and reduce the state's fiscal gap. To my surprise, I received no new ideas -- not a single one -- from any department head. Apparently no one in the governor's Cabinet has any ideas on ways to make government more efficient and less expensive. That may explain why Gov. Knowles has consistently proposed spending increases every single year he has been in office. Recently the Anchorage Daily News harshly criticized Republican Senate leaders for not supporting $35 million in spending increases proposed by the Democrats. But the Daily News ignored the fact that, this year alone, Gov. Knowles and the Democrats have offered proposals that would increase the state budget by more than $400 million -- an amount that would wipe out most reductions in state spending in the recently completed Republican Five-Year Budget Plan. 16

17 Under the Democrats' approach, Alaska would be back to square one -- and five years of deliberate work to control state spending would be lost. The only recourse left to balance the budget would be to impose major new taxes or tap into the Permanent Fund. For many of us in the Republican majority, that approach is simply not acceptable. Instead, this year we passed a budget that controls the growth of government by holding state spending increases to levels less than population and inflation increases. The Senate Finance Committee also introduced a package of legislation that continues the Republican majority's commitment to pursue fiscal responsibility and government reform -- before considering any new taxes. The legislative package represents the first step of a new long-range fiscal plan that has the potential of immediately reducing the fiscal gap by over $12 million per year -- and increasing to over $100 million per year within 10 years. Key elements of the plan include a strong constitutional spending limit, limits on municipal bond indebtedness and changes to the way the state Constitutional Budget Reserve operates. The new constitutional spending limit would replace the current ineffective amendment adopted in It would limit growth in state spending to below increases in population and inflation. The reform of the current Constitutional Budget Reserve would restore the original intent of that 1990 Constitutional Amendment. It would encourage fiscal discipline and discourage increased spending. Currently, an erroneous court decision creates the opposite effect and annually allows a small minority of legislators to force increased spending. I believe no long-term fiscal plan can be successful without first implementing these two constitutional reforms. There is no easy "fix" to Alaska's fiscal challenges. Finding solutions will take time and true bi-partisan cooperation. It will take a strong commitment to additional government reform and a resolve to find ways for government to do more -- with less. Alaskans have always prided themselves on being independent and self-sufficient. They have every right to expect their government to be the same. As co-chairman of the Senate Finance Committee, I will continue to strongly oppose any effort to balance the state budget solely on the backs of working Alaskans. Sen. Dave Donley represents District J in the state Senate. 17

18 Senator Donley s Fiscal Plan Summary by the Office of Management and Budget The package of nine bills released by the Senate Finance Committee on April 9 th was billed as a first step in a long-range fiscal plan. Major elements redistribute state resources from rural to urban Alaska, while constitutionally mandating continued reductions in the quality of public services. This package proposes a series of government reforms. It uses none of the identified fiscal policy tools except budget cutting to fill the budget gap. The Senate majority package is a piecemeal approach that doesn t have a fiscal effect that would stem the fast approaching depletion of the CBR or potential use of the ERA. The proposed legislation includes: SB 180: Geographic Pay Differential This bill would adjust geographic pay differentials to bring the regional salary adjustments for partially exempt employees into line with those already in place for classified employees. (Note: the Governor introduced similar legislation in the past.) SB 181: AHFC s 1% Housing Assistance Interest Rate Subsidy This bill would eliminate the one percent interest rate subsidy for the AHFC Housing Assistance Loan Fund Program, which makes rural housing more affordable. The differential was established to help offset the higher cost of housing in smaller communities. Sen. Donley estimates the bill would increase AHFC profits by $500,000 a year (assuming no loss in loan volume) but AHFC believes an interest rate increase of 1 percent would likely result in a minimum 50% loss of loan volume, completely negating any profits SB 182: Proration of Benefit Payments This bill would require the administration to prorate payments to individuals for statutory benefit programs like longevity bonus and adult public assistance if the legislature does not fully fund the program. This would enable the legislature to cut benefits in a back-door manner without amending the program statutes and openly debating the policy issues and impacts on people who count on these services. Similar legislation passed the House and Senate last year, but the House did not concur with Senate amendments. If a law like this were in place now, Longevity Bonus checks would be cut about 2% in FY2001 and next year s Adult Public Assistance payments would be cut about $8 per month, depending on the timing of reductions. (Medicaid would not be affected since it is paid to health care providers, not individuals.) SB 183: Public Interest Litigant Attorney Fees This legislation would limit attorney fees for public interest litigants. While Sen. Donley has included this in his package, it is a "pet peeve" type of bill that makes no significant contribution to solving the fiscal gap. Donley's own optimistic savings estimate is $117,000 per year. 18

19 Senator Donley s Fiscal Plan Summary Continued SB 184: Local Contributions to Village Safe Water Program Projects This bill would change the village safe water program statute from prohibiting a local match requirement to allowing a local match. Sen. Donley estimates savings of $2.7 million with a 5% match (no percentage is specified in the bill) but since the program is 75% federally funded, a 5% match would actually save $675,000 in state general funds. As an example: Goodnews Bay has applied for a grant of $1,666,000. A 5% local match would be $83,300 so the state would "save" $20,800. This would make the community spend $83,000 so that the state can save $21,000. SB 185: Power Cost Equalization (PCE) This bill would reduce funding for the PCE program by almost $9 million, or almost 60%, but it does not save $9 million for the fiscal gap. Instead, it reneges on prior legislative agreements of establishing an endowment to pay most of the PCE program with that fund s own earnings. The PCE floor would be raised to 20 cents per kwh and the monthly consumption cap would be lowered from 500 to 400 kwh. It would reduce payments to approximately 78,000 residents in rural Alaska and eliminate PCE in 20 rural communities. This reduction is likely to undermine the financial viability of many rural utilities, leaving the state to respond to power emergencies. SB 186: Setting a Municipal Bonding Cap This bill would amend AS to prohibit a municipality (city or borough) from issuing any new general obligation debt if its total debt would exceed $15,000 per capita. This bill specifically targets the North Slope Borough, since it is the only municipality over this per capita amount. It would make an enormous cut in the borough s future tax base. Sen. Donley claims this bill could increase state revenue by over $100 million per year within 10 years. However, the Department of Revenue's position is that because of multiple unknown factors e.g. future operating expenses and property assessments, new facilities that might be constructed within the borough Donley s estimate is highly speculative and the actual impact of the bill cannot be accurately predicted. SJR 23: Constitutional Spending Limit Since 1982 when the current constitutional limit went into place, state spending has been controlled by a combination of limited available revenues and public opinion. That s not going to change. Other states with spending limits have had surplus revenues from income/sales/corporate taxes that increased with their economic growth. The situation in Alaska is entirely different as we are looking at the decline of our resource extraction revenue and no income or sales taxes that grow with population and the economy. The logic in this legislation does not make sense in terms of what categories of spending are counted under the limit. If applied to our general fund budget history, the arbitrary 2% per year gradual growth in spending envisioned in the resolution actually results in a wildly erratic limit. The proposed limit would also have no relation to the fiscal gap. In fact, if the limit proposed in SJR 23 were currently in place, FY 02 general fund spending ($2.4 billion) would be counted as 19

20 Senator Donley s Fiscal Plan Summary Continued less than FY 00 general fund spending ($2.3 billion) even though the FY 02 fiscal gap is projected to be twice as much. Under the provisions of the resolution, any time the legislature knowingly passed a budget that exceeded the appropriation limit, the Governor would be required to impose across the board cuts on executive agency operations to reduce spending to the level of the cap. Arbitrary across the board cuts are an abrogation of the Legislature s responsibilities for setting appropriation levels. (Interestingly, SJR 23 does not apply these across the board cuts to the Legislature s own budget.) The limit would be set for FY 2004 at a level of no more than 4% above FY 2002 spending without regard to cost increases experienced by individual programs (e.g., Medicaid or the university), changes in federal requirements, increases in other fund sources such as Mental Health Trust and Public School Trust income, or court mandated expenditures. The arbitrary percentage increase in the limit has no relation to the real world drivers of public service costs such as population and inflation. We know for certain that faster than average growth of expensive cohorts of the population such as school age children or the elderly and medical cost inflation rising much faster than the overall CPI will have dramatic effects on future budgets. SJR 24: Constitutional Budget Reserve This proposed constitutional amendment would actually make it much easier to spend money in the budget reserve fund. It would achieve this by reducing the votes necessary to appropriate the CBR, and by removing whole classes of available funds (such as the Permanent Fund Earnings Reserve) from determining whether appropriations from the CBR are needed to support the prior year s budget level. While the sweep provisions would be removed, the existing $3.8 billion debt to the CBR would remain on the state s accounts. 20

21 Major Categories of State Spending Total Funds Budget Much of the $7.4 billion total state budget has restrictions on how the money is spent. Of this amount, the capital budget is $1.3 billion, with $925 million of that coming from federal funds, mostly for transportation projects. Permanent Fund Earnings Another $1.8 billion is Permanent Fund earnings that go to pay for dividends ($1.1 billion) and inflation proofing ($700 million). The PFD program is by far the largest single state expenditure and has been the fastest growing program for the past decade. Federal Funds About $2.1 billion is federal funding which has restrictions on how it may be spent - requires a $253 million state general fund match along with maintenance of effort requirements. Other Funds A little over $1 billion comes from sources such as university tuition receipts, AHFC dividend, endowment and trust receipts. Most of these funding sources have restrictions on how they may be spent, e.g., AHFC FY 2002 General Fund Budget by Program Area Capital and Operating: $2.4 Billion All Other (Admin., Revenue, Governor, Legislature, etc.) 14% - $331 Million K-12 Education Formula* Support 29% - $706 Million All Non-Education Formula* Programs 14% - $328 Million Natural Resource Management 4% - $96 Million Debt Service 4% - $105 Million Health and Social Services 6% - $141 Million Transportation 7% - $159 million University of Alaska 8% - $203 Million Public Safety/ Justice/ Corrections 14% - $343 Million *Formula programs are based in statute and guarantee a specific level of benefits to qualified recipients. Non-education formula programs include: Medicaid, Adult Public Assistance, Longevity Bonus, Revenue Sharing, Foster Care, Elected Officials Retirement, Shared Fisheries Business Tax and Temporary Assistance. 21

22 Formula Programs $1.6 billion goes for formula programs where the level of funding is determined by a formula set in statute largest are K-12 education at $782 million and Medicaid at $577 million. Others include revenue sharing, longevity bonus, welfare, and foster care. General Fund Budget General funds are mostly oil revenues and the legislature has complete discretion over how they may be spent. The fiscal gap is measured as the difference between general fund revenues and general fund expenditures. The large majority of expenditures in the general funds budget are committed to services that most people recognize as standard government functions. These include: K-12 education (29%), formula programs (14%), public safety (14%), university (8%), transportation (7%), health and social services (6%), natural resource management (4%) and debt service (4%). The remaining 14% piece represents all other general government functions. These include economic development, senior services, public health, motor vehicle services, revenue collection, finance, the legislature and governor s office. FY 2002 Total Funds Budget by Program Area Capital and Operating: $7.4 Billion Debt Service 3% - $204 Million Health and Social Services (Non-Formula) 5% - $385 Million All Other Services 7% - $625 Million Permanent Fund Inflation Proofing and Dividends 26% - $1.8 Billion Transportation 17% - $1.3 Billion Natural Resource Management 6% - $409 Million Public Safety/ Justice/Corrections 6% - $476 Million University of Alaska 8% - $614 Million All Non-Education Formula* Programs 11% - $837 Million K-12 Education Formula* Support 11% - $782 Million *Formula programs are based in statute and guarantee a specific level of benefits to qualified recipients. 22