One argument some routinely make to rationalize using PFD cuts to fund government instead of “taxes” is that “if it used taxes, the Legislature could increase the burden by raising the tax rates.”
The implication is that the Legislature somehow isn’t able to increase the effective tax rate (the “burden”) on Alaska families when using PFD cuts and that, as a result, the vast majority of Alaska families are contributing less by using PFD cuts to fund government than they would with taxes.
But that’s dead wrong. As the experience over the past six years that the Legislature has been using PFD cuts to fund government – an approach former Governor Jay Hammond labeled in Diapering the Devil as “a reversibly graduated head tax on all and only Alaskans” – demonstrates, not only can the Legislature raise the effective tax rate on Alaska families using PFD cuts, it has done so to a far greater extent than it likely would have been able using other tax approaches.
The fact is over the past six years the Legislature has repeatedly and significantly increased the amount of annual revenue it is raising through PFD cuts.
In FY17, when former Governor Bill Walker initiated the approach, he used PFD cuts to withhold and divert (tax) a bit under $700 million to government. Since then, the annual amount of PFD revenue withheld and diverted (taxed) to government has grown over 2.5 times, to the point that in the current FY22 budget PFD cuts are now being used to withhold and divert nearly $1.8 billion from the pockets of Alaska families to government.
Viewed another way, using PFD cuts the Legislature has raised, on average over the last six years, over $200 million in incremental (additional on top of the previous year) “new revenue” each and every year.
The magnitude of the growth in the amount the Legislature has withheld and diverted (taxed) from the PFD is sometimes lost when graphed as a share of the overall statutory PFD. Because the portion of Permanent Fund earnings designated by statute for the PFD also has grown over the period, the growth in the portion diverted (taxed) to government doesn’t necessarily stand out as significant.
But the growth in the amount withheld and diverted (taxed) becomes clear when graphed on its own. The amount diverted (taxed) to government has declined from the previous year in only one of the six years the approach has been used (FY20, the first Dunleavy budget). In the other five years the amount diverted (taxed) has increased over the prior year, and over the past two years alone the amount diverted (taxed) has more than doubled.
Comparing these results to the equivalent rates that would be required to raise the same amount of “new revenue” using other forms of taxation is eye opening.
In its 2017 study for the Legislature, the Institute on Taxation and Economic Policy (ITEP) analyzed five different options for raising revenue, boiling each down to the rate needed to raise $500 million in “new” revenue. For purposes of this column we have looked at the two, other than PFD cuts, that have received the most attention since – a sales tax and a progressive income tax.
Using the sales tax approach analyzed in the 2017 study, the nominal sales tax rate required to raise $500 million was 3%. Using the income tax approach analyzed in the 2017 study, the marginal tax rates required to raise $500 million stair stepped from 0% for the first $20,600 in taxable income (married, filing jointly), ultimately up to a nominal 5.0575% on taxable income of $500,000 and above. The marginal tax rate on the average middle income Alaska household, with income of $55,000, was a nominal 2.89%.
For purposes of this column, to those we have added a third approach based on ITEP’s subsequent, 2021 study for the Legislature of various flat tax alternatives. The approach we have used is labeled in the study as “Option 1,” which raises $696 million at a nominal 2.5% tax rate. That scales to a nominal 1.9% tax rate to raise $500 million.
To calculate the rates which would be required under the various alternative approaches to raise the same revenues as diverted (taxed) from the PFD over the last six years, we have simply scaled the applicable nominal tax rates at $500 million up to the required levels. The results are as follows:
The picture painted by these results is staggering. To raise the same amount of money as diverted (taxed) from the PFD over the six year period between FY17 and FY22, state sales tax rates would have been required to grow from 4.1% to 10.6%, the top marginal rate of the progressive income tax from 6.9% to 17.9%, the average middle income marginal rate from 2.5% to 6.4% and the flat tax rate from 3.4% to nearly 9%.
Those represent an annual compound growth rate of over 20%.
To raise the incremental $900 million per year in annual “new revenue” diverted (taxed) from the PFD just between FY20 and FY22 alone would require more than doubling any of the tax rates, lifting the sales tax rate from 4.9% to 10.6%, the marginal income tax rates from 8.3% to 17.9% (top level) and from 3.0% to 6.4% (middle income) and the flat tax rate from 4.1% to 8.9%.
It is highly unlikely that, faced with the resulting political blowback, the Legislature would have voted to expand the tax rates to anywhere near those levels. As Governor Hammond observed in Diapering the Devil, “after all, the best therapy for containing malignant government growth is a diet forcing politicians to spend no more than that for which they are willing to tax.”
Yet, that is exactly what the Legislature has done using PFD cuts instead.
In effect, using PFD cuts instead of other approaches has enabled the Legislature to impose year-on-year tax increases on Alaska families at extraordinary rates. Not only has the Legislature been able repeatedly to raise the effective tax rate on Alaska families, the cumulative effect has pushed those rates to stratospheric levels. Using PFD cuts, the vast majority of Alaska families are now contributing much more to fund government than they would have with any other tax approach.
So, why hasn’t there been an outcry?
In large part, because PFD cuts essentially are a “stealth tax.” When the Legislature uses other tax approaches to raise revenue, it has to set a transparent “tax rate” – for example, a “3%” sales tax, or a “4%” income tax rate – that Alaskans can see, use to judge fairness and push back on if they think they are too high.
The Legislature doesn’t do that for PFD cuts, however. Instead, it just takes the money in bulk, without ever publishing the “rate” of the burden it is imposing as a result on Alaska families. Without a transparent rate, there isn’t a number that Alaskans see and can use to judge the fairness of the approach.
The “stealth” aspect is furthered also by the massively unequal distribution of the burden. As we’ve explained in previous columns, the burden of using PFD cuts to fund government falls hardest on middle and lower income Alaska families. The top 20% are barely scratched.
Even at $1.77 billion, using PFD cuts to fund government only takes 2.8% as a share of income from the top 20%. The impact is even lower for the top 5% (1.4%) and top 1% (0.7%). Those are less than the marginal income tax rate on those income brackets even at $680 million. They certainly aren’t going to sound the alarm and push for another tax approach.
The reverse is true, however, for middle, including upper middle, and lower income Alaska families. At equivalent revenue levels, any of the other tax options take less from middle and lower income Alaska families than PFD cuts.
For example, at $1.77 billion, using PFD cuts takes 8.9% as a share of income from middle income Alaska families. At the same level a sales tax, the next most burdensome, would only take 5.3%; an income tax would only take 2.5%. The disproportionate impacts on the other income brackets further down the scale are even larger.
But because those below the top 20% don’t have the same resources (accountants, lawyers, lobbyists) to identify – and do something about – those differences, the alarm doesn’t sound. The “stealth” tax of PFD cuts just continues to grow unabated.
The bottom line is this. Using a transparent tax approach – one that uses an explicit tax rate – effectively would cap the share of income the Legislature is taking from Alaska families. No doubt there would be an intense debate about whether it should be a 3% sales tax, or a 4% flat tax, or a 5% (marginal rate) income tax, or whatever. But once set it largely would cap the revenue available to the Legislature for an extended number of years. As Governor Hammond anticipated, Alaskans likely would firmly resist further efforts to change it.
But that’s not happening using the “stealth tax” of PFD cuts. Not only is the Legislature increasing every year the amount of revenue it is taking from Alaska families, it is increasing the share of income it is taking to truly extraordinary levels. Instead of the 1.5% share of income a 3% sales tax would take from a middle income Alaska family, current PFD cut levels are diverting (taxing) to government instead nearly 9% of that same family’s overall income.
Sort of like the proverbial frog in the pot of boiling water, the impact of raising revenues through PFD cuts on the vast majority of Alaska families just continues to grow more and more severe while they sit largely unaware of what is happening.
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.