Regular readers of these columns know that we often discuss the regressive impact of using cuts in the Permanent Fund Dividend (PFD) – what former Governor Jay Hammond called in his book, Diapering the Devil, a “head tax” – to pay for Alaska state government. But we’ve never brought that impact down to what it means in terms of dollars and cents per middle and lower income Alaska family.

We’ve also never calculated the amount of the financial benefit – effectively, an artificial windfall created solely by Alaska fiscal policy – received by the wealthiest 20% of Alaska families and non-residents (who avoid contributing anything toward the costs of Alaska government using PFD cuts) resulting from that approach.

This week’s column does both.

As background for those new to the issue (including some newly elected to the coming Legislature), what we are addressing is the distributional impact of using PFD cuts to fund state government compared to alternatives. In 2017, a study for the legislature prepared by the Institute on Taxation and Economic Policy (ITEP) looked at the impact of various funding options – including a progressive state income tax, a state sales tax, reductions (cuts) in the PFD, a payroll tax and a payroll and investment tax hybrid – on Alaska families, by income bracket.

In a subsequent, 2021 study ITEP also looked at the same impact by income bracket of using a flat rate income tax (flat tax)

The 2017 study concluded that:

… reductions in the PFD are steeply regressive, having a far larger impact on families with lower incomes. Figure 5 demonstrates that while a $784 cut to the PFD payout could free up approximately $500 million for Alaska’s budget, that gain would come at a high cost for Alaska’s most vulnerable residents. Low-income families could expect to see their incomes cut by 7.2 percent under this change while the impact on middle-income families would amount to 2.5 percent and high-income Alaskans would see impacts well below 1 percent of their incomes.

… Those results show that the impact on the bottom 20 percent of earners (at 7.2 percent of income) is nearly ten times as large as the impact faced by the top 20 percent (at 0.8 percent of income).

The accompanying graph put it this way:

The 2017 study also compared that impact to the other alternatives. The impact of PFD cuts literally stick out like a sore thumb. According to the study:

Cuts to the PFD payout are the most regressive option examined in this report, followed by a statewide general sales tax. A PFD cut would impact the bottom 20 percent of earners nearly 10 times as heavily as the top 20 percent, when measured relative to family income. A statewide general sales tax would also be regressive, costing low-income earners more than three times as much, relative to their incomes, as high-income earners.

Graphically, the comparison looked like this:

As the chart shows, PFD cuts take significantly more from both lower and middle income – combined, 80% of – Alaska families than any other option. While using a progressive income tax the top 5% would contribute more as a share of income, even then they would contribute less as a share of income (2.4%) than PFD cuts take from middle (2.5%) and lower income (7.2%) Alaska families.

ITEP’s conclusions also are supported by a separate, 2017 study done by researchers at the University of Alaska – Anchorage’s Institute of Social and Economic Research (ISER). As they summarized:

A cut in PFDs would be by far the costliest measure for Alaska families. Households with children would pay about 2.5 times more per person than those without children, for every $100 million of revenue raised. A big reason is that children receive PFDs—so PFDs make up a bigger share of income for households with children.

Sales taxes would be the next costliest for households with children. Again, those households tend to have lower incomes; sales taxes are the same for everyone, so they take a bigger share of the income of poorer households.

So, we know that, as a share of income, using PFD cuts to fund government generally results in middle and lower income – working – Alaska families paying much more – and the wealthiest 20% and non-residents, the latter of which don’t contribute anything using PFD cuts, much less

The question we address in this column is how much more, and how much less. What’s the amount of the penalty to middle and lower income Alaska families; what’s the amount of the windfall to the wealthiest 20%.

To do that, we need to establish two baselines. The first is “compared to what.” Given current and projected spending and other revenue levels it’s clear that Alaska state government will require some additional funding to balance the state budget over the coming decades. Even Governor Mike Dunleavy’s (R – Alaska) most recent 10-year plan, released yesterday in conjunction with his FY24 budget proposal, admits that.

In order to calculate how much middle and lower income Alaska families are overpaying – and the wealthiest 20% and non-residents underpaying – we need to establish what they would pay under the alternative.

The second baseline is what the size of the deficits are that need to be covered through additional funding. The larger the deficit, the more that middle and lower income Alaska families are overpaying by using PFD cuts.

We establish the first baseline using a flat tax taken from the 2021 ITEP study. We use a flat tax because it is relatively neutral among the income brackets, taking roughly the same as a share of income from all Alaska families.

We would also note that, in the past 18 months alone, five states have converted their primary tax system to a flat tax in order to achieve revenue neutrality among taxpayers – to take the government out of the business of subsidizing some taxpayers at the expense of others.

The flat tax we use is Option 1 from the 2021 ITEP study. We use that because it has the broadest base and the least number of exclusions and exemptions, which results in the lowest and most neutral impact of any of the alternatives analyzed in the study.

We establish the second baseline using a deficit of $1 billion. That is the average annual current law deficit we calculate over the next decade in our most recent current law “Goldilocks chart” ($1.4 billion), offset by the impact of making the two adjustments in oil taxes (closing the Hilcorp loophole and reducing the per barrel tax credit by $3) we discussed in a previous column and are included in the Department of Revenue’s most recent (April 2022) “Fiscal Model.”

We include the oil tax offset because we assume that, going forward, the state will raise oil taxes to the “revenue maximizing” point included in the Fiscal Model before imposing any taxes on individual Alaska families.

Using the 2017 and 2021 ITEP studies, here’s the resulting tax rates by income bracket necessary to raise $1 billion under the two – PFD cuts and Option 1 Flat tax – alternatives.

As is clear from the charts, the flat tax option takes less than PFD cuts for 80% of Alaska families. While the flat tax rates are higher than using PFD cuts for the wealthiest 20%, the resulting rates are still lower than the impact of using PFD cuts on the other 80% and within 1% of the flat tax rates applicable also to the other 80%.

So applying that, how much are working – middle and lower income – Alaska families overpaying using PFD cuts?

Using the data from the 2017 and 2021 ITEP studies, here’s a comparison of what middle and lower income – again, 80% of – Alaska families are losing in terms of PFD cuts compared to what they would pay if the state instead used a flat tax to raise $1 billion in funding.

While the dollar amounts may seem low to those in the top 20%, they are significant to those in each bracket.

By using PFD cuts, on average households in the lowest 20% are losing $1,902 in annual income which, using the data from the 2017 and 2021 ITEP studies, represents nearly 12% of their annual income. At the same time, lower middle income households are losing $1,420 (4.6%), middle income households $1,187 (2.2%) and upper middle income households $220 (0.2%).

On the other hand, the wealthiest 20%? They are making out like bandits as a result of using PFD cuts instead of a flat tax.

While 80% of Alaska families are losing money using PFD cuts, on average households in the top 20% are pocketing an extra $3,740 (1.5% of annual income). And that just scratches the surface. Households in the top 5% are pocketing $10,298 (2.1%) and those in the top 1%, those already with average incomes of around $1.3 million, are adding an additional $31,205 (2.4%) to income solely as a result of PFD cuts instead of a flat tax.

Non-residents are doing even better yet. Unlike in any other state – all of which use some form of tax that reaches non-residents – by using PFD cuts to raise revenue, in Alaska non-residents contribute nothing.

Put another way, in the aggregate those in the lowest 80% of Alaska families are overpaying by $334 million annually, so that those in the top 20% are able to underpay by $269 million and non-residents, who would otherwise contribute roughly 7% ($70 million) of the state’s additional funding requirement, are able to escape, as Governor Hammond put it in Diapering the Devil, “scot-free.”

In short, through the use of PFD cuts instead of a flat tax as the means of funding government, past legislatures have made middle and lower income Alaskans poorer, and the wealthiest 20% of Alaska families even richer.

Some wonder why this past year “Alaska was the only state to see a decline in median income in 5-year census survey.”

As we’ve explained in a previous column, we don’t. The part controlled by state fiscal policy is tilted – heavily – in favor of making the wealthy even better off at the expense of the remaining 80% of Alaska families.

Next week we’ll have our first take on Governor Dunleavy’s new budget and 10-year plan.

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.