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We Build Alaska

Brad Keithley’s chart of the week: “Most regressive tax ever” & one other big thing

Occasionally, we wonder if we are just a lone voice shouting into the wind about the impact of cuts in the Permanent Fund Dividend (PFD) on Alaska families and the overall Alaska economy.

We haven’t been wondering that lately, but if and when we do again in the future, all we will need to do is click on the op-ed that appeared late last week in the Anchorage Daily News (“A better way to balance Alaska’s budget”) written by Dr. Matthew Berman, a Professor of Economics on the faculty of the University of Alaska Anchorage’s Institute of Social and Economic Research (ISER), and reread this passage:

Let’s be honest. A cut in the PFD is a tax — the most regressive tax ever proposed. A $1,000 cut will push thousands of Alaska families below the poverty line. It will increase homelessness and food insecurity. … Progressives like [Representative Zack] Fields [D-Anchorage] who advocate for using PFD cuts to pay for public spending should think again.

These aren’t idle musings on Dr. Berman’s part. He has studied the issue in depth.

He was one of the original three ISER researchers (along with the now-retired Gunnar Knapp and the now-departed Mouhcine Guettabi) that authored the detailed 2016 ISER study on the economic impacts of Alaska’s fiscal options to which we refer often and which concluded, among other things, that, of the various options, PFD cuts have the “largest adverse impact” on the overall Alaska economy.

Later that year, he also co-authored a study of the impact of PFDs – and PFD cuts – on poverty (“How PFDs Reduce Poverty in Alaska”), which concluded, “[r]educing or eliminating PFDs to help fill the budget gap will significantly increase the number of Alaskans below the poverty threshold.”

And then, the following year, he also co-authored the “Effect of Alaska Fiscal Options On Children and Families,” which concluded, again of the various options, that “[a] cut in PFDs would be by far the costliest measure for Alaska families.”

Throughout, the message has been consistent. Of all the various funding options available for balancing the Alaska budget, diverting Permanent Fund earnings from the PFD to fund government (i.e., cutting the PFD) has the worst impact on Alaska families, the economy, jobs, and income.

Any of the broad-based revenue alternatives, even a regressive sales tax, is better.

But Dr. Berman’s piece is important for more than succinctly restating the problems with using PFD cuts to balance the budget. It also offers a much better way forward.

One of the most repeated rationalizations advanced over the past six years for using PFD cuts to fund government is that because PFDs are taxable at the federal level, a portion of the PFDs distributed to Alaska families ultimately ends up in the hands of the federal government. Some argue that impact alone justifies cutting PFDs because, by reducing the portion that goes through Alaskans’ hands to the federal government, the cuts increase the amount that is retained in the state for use to “help” Alaskans.

As we explained in a previous column, that impact is offset when compared to other alternatives. For example, while PFD cuts take money only from Alaska families, both sales and income taxes also raise revenue from non-residents. Because of those and other characteristics, when comparing the inflows and outflows of PFD cuts compared to those alternatives, the effect is a wash.

While the Alaska economy may lose some of the dollars distributed as a PFD to the federal government (what some describe as “leakage”), using other alternatives that include non-residents to raise the same amount of revenue reduces the dollars taken from the Alaska economy to the same extent (“reverse leakage”).

Looking at the outflow and inflow of dollars into Alaska, Alaskans – and the Alaska economy – come out the same either way. As we explained in that column, because the various approaches are a fiscal wash, the decision of which revenue measure to use should be based on other characteristics, most significantly, the hugely regressive impact of PFD cuts on Alaska families and, through them, the adverse impact of them on Alaska income and jobs.

But Dr. Berman’s piece describes an approach through which the federal leakage from the PFD can be significantly reduced, making that approach more fiscally advantageous to Alaskans as well.

Here is Dr. Berman’s proposal:

What if … we distributed the statutory PFD as a refundable tax credit [as an offset to] a state income tax. The PFD would be paid as a credit against the state taxes owed. If the PFD exceeded our individual tax liability, the state would issue us a check for the difference. Higher-income Alaskans would [use the full credit against taxes]. A PFD tax credit isn’t taxable income, so the feds couldn’t tax it.

The federal leakage those focused on the issue have expressed concern about occurs largely at the upper-income levels, where additional income is subject to federal marginal tax rates ranging from 22% to 37%. They view the PFD as marginal income, and thus, the portion going to those in the upper-income brackets as subject to federal leakage of the same amount.

Here is the concern expressed in graphic form, using for this example the 2022 current law (statutory) PFD, a married couple with two children, and the federal marginal rate transition levels for tax year 2022:

For those households with income of roughly $690,000 and up, 37% of the $14,160 in PFDs they would receive at current law levels (or roughly $5,240) would go to the federal government in income taxes. The chart shows what the amounts would be at lower income levels.

But that wouldn’t occur using Dr. Berman’s approach. Using a flat tax to close the deficit, for example, the state tax obligation for households in the upper-income brackets would exceed the PFD. If the PFD was used as a refundable credit, the full amount of the PFD would be used as an offset to the state income tax obligation. None of the amounts would be treated as federal taxable income, and thus, no leakage would occur.

Here is the effect of that approach using the same example as above and including the state tax rate at the 6% flat tax rate we calculated in last week’s column required to cover projected state deficits over the next decade:

While there continues to be some leakage at lower-income brackets, the leakage would be reduced to zero at the upper-income brackets, where most of it occurs. And even where it continues to occur at lower income levels, the extent of the leakage would be reduced. Not only are the marginal rates lower at the lower income brackets, but using a flat tax approach based on Adjusted Gross Income (AGI), all households would have some tax obligation and, thus, use the PFD as a credit to some extent.

One subsequent commentator has claimed that Dr. Berman’s approach could be made “even better” by eliminating the credit approach and simply turning the PFD into a means-tested program with the PFD only paid to “low-income people.” The commentator claimed that by doing that, “we save the cost of standing up an entire organization in Juneau to collect income taxes and issue credits.”

But that’s false and reveals a gross misunderstanding of both Alaska’s fiscal situation and Dr. Berman’s proposal. The state tax is required to close the deficit. At higher income levels, it produces revenue much greater than the credit. For example, looking at the chart above, at a 6% flat tax, those with roughly $670,000 in income would be responsible for contributing roughly $41,625 in tax.

Eliminating the tax component and capping their obligation at the size of the PFD would result in the under-recovery of roughly $27,500 in state revenue. Moreover, eliminating the tax would mean non-residents would continue to avoid any contribution toward state costs. Multiplied over the entire state, that would put us back near to where we are now, with a huge, uncovered deficit.

As we explain in a previous column, the net result of the commentator’s approach is that not even the lowest-income Alaska families would receive the full PFD. While slightly less than those required currently, deep PFD cuts would nevertheless need to be continued in order to cover the deficit.

Because it would require PFD cuts at a minimum and, potentially, the elimination of the PFD also for them, a needs-based approach also would adversely impact middle-income Alaska families. While they would fare better than lower-income families, by using continued PFD cuts to close the deficit, they also would end up contributing more to government as a share of income than the top 20%.

While some may not immediately recognize it, Dr. Berman’s column significantly advances the ball on Alaska fiscal policy. By offering a method that significantly reduces federal leakage of PFDs, the approach makes the advantage of retaining the PFD and using a tax instead to close the deficit even more compelling.

It is important to understand also that this advantage accrues uniquely to income taxes (whether flat or progressive). There is no similar mechanism for using PFDs as a credit against sales taxes. As a result, the full amount of federal tax “leakage” some have been concerned about would continue under a sales tax approach.

In short, no longer are PFD cuts and income taxes a financial wash. By reducing the “leakage” of PFDs while maintaining the non-resident “reverse leakage” of income taxes, Dr. Berman’s approach makes the case for income taxes both financially and distributionally superior.

Hopefully, some of the more serious and financially savvy legislators will see the same advantages and work toward incorporating Dr. Berman’s approach into their analysis (and a resulting bill) soon. We have already started to make the necessary adjustments to do so with the draft of our long-proposed flat tax bill.

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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Retired and below the poverty level
10 months ago

Thank you for being the voice of reason.

Jeff
10 months ago

Maybe we could start by not paying a pfd to people who no longer live in the state. The loophole that allows people who move out of state but “intend” to return should be eliminated. If you move out of state you should no longer be allowed a pfd

Brad Keithley
10 months ago
Reply to  Jeff

Let’s assume that’s 10%. That only increases the per-household PFD in the examples above to $15,733, increasing the breakeven to roughly $260,000; it doesn’t eliminate the problem by any stretch. (Recall that the PFD is calculated by dividing 50% of earnings (the numerator) by the number of recipients (the divisor). Reducing the number of recipients (the divisor) only increases the per-recipient PFD; it doesn’t reduce the amount of earnings distributed as PFD.)

Grateful Alaskan
10 months ago

Mr. Keithley, do you think a flat tax has any hope of passage with the Governor taking “No Income Tax” as his only apparent “must have” fiscal item? (he seems to have abandoned the statutory PFD with little fanfare, and haven’t heard him make any real noises about trying to stand firm at the 50/50 POMV amount either)

Or should the legislature be operating under a “no flat tax without a new Governor” assumption?

Brad Keithley
10 months ago

Excellent question. While he clearly has said “no income tax,” as you point out, this Governor also has demonstrated a willingness and ability to change his fiscal positions fairly often over his time in office. My approach is to keep pushing for the best possible approach for both Alaska families and the overall Alaska economy and hope the politicians catch up to it at some point.