Brad Keithley’s chart of the week: How Alaska can control oil revenues

One of the complaints we have heard often at the start of this legislative session is how state oil revenues are volatile and can’t be controlled.

That’s false. State government oil revenues can be controlled and made predictable for budget purposes. It’s just that we’ve chosen not to.

How could we control them?

Exactly the same way we have other revenue sources. While perhaps not as much as oil revenues, when looked at on a year-to-year basis Permanent Fund investment levels and statutory net income are also relatively volatile and unpredictable. If we were using a one-year, forward looking projection of those on which to base the percent of market value (POMV) draw and Permanent Fund Dividend (PFD) in each year’s budget we would similarly become frustrated by their “volatility” and “uncertainty.”

But we don’t include the numbers for them in each year’s budget on the basis of a one-year, forward looking projection.

Instead, in order to smooth out the volatility and likely ensure we have the revenues in hand before spending them we use historical averages for both. In the case of the POMV draw, it’s “the average market value of the fund for the first five of the preceding six fiscal years, including the fiscal year just ended.” In the case of the PFD, it’s “the net income of the fund for the last five fiscal years, including the fiscal year just ended.”

We easily could do the same with oil revenues.

Even using the same 5 -year average as used for the POMV and PFD would be an improvement. Here we chart traditional unrestricted general fund (UGF) revenues (oil revenues plus existing fees and taxes) received by year (in blue) compared to the running 5-year average (in red):

While still variable, using a 5-year average at least moderates the highs and softens the lows. Even more importantly, it pushes the effects of any price surge forward, so that the Legislature has some perspective on where actual future prices are headed before they spend the revenues from the surge.

For example, by using a 5-year average, the Legislature would have seen in 2014, when the 5-year average was peaking, that actual year-to-year revenues already were dropping. Instead of spending all of the peak, with that additional perspective the Legislature likely would have been more cautious as it dealt with the benefits of the 2011-12 price surge.

But the Legislature is not limited only to using 5-year averages, and other approaches most likely would fit traditional revenues even better.

Here’s the effect, for example, of using a 10-year rolling average, entirely reasonable given the level of volatility involved in oil prices.

Using a 10-year average would moderate the highs, and soften the lows even more than the 5-year approach, and by pushing the effects of price surges out even farther, also allow the Legislature to have a somewhat counter-cyclical impact on the state’s overall economy as that economy otherwise gyrates between strong and weak oil cycles.

Moreover, it would empower the Legislature with even more perspective before it acted on revenues received during high oil periods. As peak revenues arrived in 2016, for example, the Legislature already would have seen the precipitous price drops in 2013, 2014 and 2015. That would have provided it with useful information from which to exercise much better judgment about whether it should rush to spend the benefits from the price spike all at once.

And there’s an additional step that would moderate the flow of annual revenues even more. That is to put “sideboards” – not to exceed limits – on the rate of change in any given year.

In a previous column we discussed applying a 15% sideboard to the flow of revenues for budgeting purposes – that is, traditional revenues used for budgeting purposes could not increase (or decrease) in any one year by more than 15%.

But there is nothing magic about 15%. Instead, the goal should be to develop a mechanism that achieves the objective. After analyzing a few, we believe a 5% sideboard (on the 10-year average) would produce the best result.

Here’s the result: the revenue flow for budgeting purposes resulting from using the rolling 10-year average with a 5% sideboard is in brown.

As actual traditional revenues (blue) and even 10-year average revenues (red) gyrate up and down in response to the oil price rollercoaster, by using a 5% sideboard traditional revenues available for government remain relatively stable, with some – but only some – variation from year to year.

Under this approach, the differences each year between actual traditional revenues received and those used for budgeting purposes would be deposited into or withdrawn from a separate, “stabilization” subaccount of the Constitutional Budget Reserve (CBR). Here’s how that would look, if it had been started in 2012.

The amount deposited in the CBR – the difference between actual revenues received during the fiscal year and the revenues used for budgeting purposes – would have grown during periods of high oil prices and been drawn down during periods of low oil prices. By the end of FY21 the balance would have been $6.2 billion.

That would grow over the coming years if the oil prices – and related revenues – projected in the Department of Revenue’s (DOR) most recent 10-year forecast materialize. But a significant reserve would remain to soften the impact even if, as some believe, oil prices instead underperform in the coming years.

On the other hand, if the oil prices projected in DOR’s forecast do materialize, then the reserve would be available to continue to spread the wealth of Alaska’s oil resources even to those of Alaska’s future generations that come after oil revenues decline.

In short, rather than Alaska being the tail on the oil price dog, gyrating back and forth as the dog twitches, Alaska would be in control of its own destiny, converting those gyrations into, like the averaged POMV draw and PFD, a relatively steady stream of revenues at least for as long as the oil dog lasts, if not longer.

Some argue that reducing the level of traditional revenues available some years to support the budget would result in harmful reductions in spending levels.

But that’s not true. All that it would do is require current Alaskans to contribute something toward the costs of their current government.

Using the proposed UGF spending levels contained in the Administration’s FY24 10-year plan as a baseline, and restructuring the PFD to the POMV 50/50 approach recommended by Governor Mike Dunleavy’s (R – Alaska) FY21 10-year plan and the 2021 Legislature’s Fiscal Policy Working Group, here’s the relative contributions that would be required to support the same spending outcome.

Rather than rely entirely on “free” oil revenues, Alaskans themselves would be required to contribute something toward the cost of their own government.

But not much.

Averaged over the FY24-32 period, the amount of “other revenues” required would be about $700 million per year, roughly 14% of overall revenues averaged over the period.

In its recent Overview of the Governor’s (FY24] Request, the Legislature’s Legislative Finance Division (LFD) estimated that “an individual income tax based on 3% of AGI [federal Adjusted Gross Income], with no exemptions or deductions [i.e., a flat tax], would generate $900 million in the first full year administered.” At 2.3% of AGI, the level required to raise $700 million, the impact would be significantly less on most Alaskans than continuing to use ever-deepening PFD cuts.

And the required level of “other revenues” could be reduced even further if, as part of smoothing traditional revenues or separately, the Legislature raised some part from restructured oil taxes.

Some think that the answer to Alaska’s fiscal situation is a restructured “spending cap.” But at its core all that the proponents of a spending cap are trying to achieve is indirectly to control oil revenues. They want the cap so that Legislative spending levels are restrained from spiking as oil revenues periodically surge.

But we see significant problems with the proposed “spending cap” proposals currently on the table. Instead, we think managing oil revenues directly in the same way we currently manage POMV and PFD revenues – by using a rolling average as the basis for budgeting purposes – is the much better course.

In short, we wouldn’t need an artificial spending cap if we manage the flow of oil revenues into the budget in the same way we manage the flow of Permanent Fund earnings revenues into the POMV and PFD.

Finally, managing the flow of oil revenues into the budget on the basis of rolling averages would better spread the benefits across generations. One of the things we find most troublesome about the current approach to oil revenues is that it arbitrarily advantages those who happen to be living in the state at the time of oil price surges and, conversely, arbitrarily punishes those who happen to be living in Alaska at the time of oil price plunges.

As the charts above indicate, managing the flow on the basis of historic averages, particularly with sideboards, would stabilize and spread out the benefit of surges, and moderate the adverse impact of plunges, across multiple years and, through that, generations. All Alaskans would benefit to some degree from the price surges, and understand the need for moderation from the price plunges, regardless of the year(s) they happen to live in the state.

Instead of intergenerational “winners” and “losers,” all Alaskans would benefit roughly equally from this aspect of the state’s resource wealth regardless of generation.

Yes, oil prices have had a hugely volatile impact on Alaska’s budget and residents over the years. But it doesn’t have to remain that way. There is a simple fix that we already use for other revenue purposes. All that we have to do is apply it to oil revenues as well.

Brad Keithley is the Managing Director of Alaskans for Sustainable Budgets, a project focused on developing and advocating for economically robust and durable state fiscal policies. You can follow the work of the project on its website, at @AK4SB on Twitter, on its Facebook page or by subscribing to its weekly podcast on Substack.

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