Over the course of the past few months, there have been a series of articles in the press about a purported developing problem with the Permanent Fund earnings reserve and, now, more recently, about a restructuring proposal being developed by the Permanent Fund Board to deal with the purported problem.
As we’ve explained in previous columns – here and here – we are far from convinced the developing “problem” is real. Rather, it appears more to us to be the contrived outcome of some highly “creative” accounting steps that, among other things, completely ignore two large ad hoc transfers made from the Permanent Fund earnings reserve to the Permanent Fund principal (sometimes referred to as the “corpus”) in FY2020 and FY2022.
But even if there is a “problem,” the restructuring proposal being developed by the Permanent Fund Board is a horrible idea. As the proposal is described in a recent article in the Alaska Beacon, the effect would be to amend the Alaska Constitution to enable the Legislature effectively to start drawing down the Permanent Fund principal in order to support continued spending.
It would do that by enabling the Legislature to continue to make percent of market value (POMV) draws from the Permanent Fund even if the earnings from the Fund were insufficient to support them.
Here is the potential effect in graph form. For illustrative purposes, this chart assumes the Legislature continues to make annual POMV draws at the current rate of 5% while what economists call the underlying “real” (after inflation) rate of return earned by the Fund is only 4% over the same period, resulting in a 1% annual real draw in excess of earnings.
Over the period from FY2023 through FY2050, the real dollar level of the Permanent Fund principal would decline from $67.5 billion to $51.5 billion. Because the POMV draw is calculated as a set percent of the principal and the principal is declining, the real dollar level of the POMV draw also would decline from $3.4 billion at the start of the period to $2.6 billion at the end.
Alternatively, by slightly tweaking the language, the proposal could potentially also be used to keep the real dollar level of the POMV draw the same. Here is the effect of that, assuming the POMV draw is kept whole at the same real dollar level even though earnings are continuing to decline.
Over the period from FY2023 through FY2050, the real dollar level of the Permanent Fund principal would decline from $67.5 billion to $35.7 billion. While the real dollar level of the POMV draw would remain constant at $3.4 billion, because the real dollar level of the Permanent Fund principal is declining, the POMV rate would escalate dramatically, from 5% at the start to over 9% by FY2050.
Finally, with some slight additional tweaking, the proposal might even permit the Legislature to increase the POMV draw at an even greater rate in an effort to keep overall real unrestricted general fund (UGF) revenues whole as traditional (mostly oil) revenues continue to decline. Here is the effect of that, assuming the dollar level of real (after inflation) POMV draws are increased by 2% annually even though earnings are continuing to decline.
Over the period from FY2023 through FY2050, the real dollar level of the Permanent Fund principal would decline from $67.5 billion to zero. While the real dollar level of the POMV draw would remain constant at $3.4 billion, escalated at 2% per year, because the real dollar level of the Permanent Fund principal is declining, the POMV rate would escalate dramatically from 5% at the start to over 27% by the time the Permanent Fund is completely drained.
Why would anyone make such a proposal? One simple reason. As with previously draining the state’s “rainy day” savings funds, and then, after those were essentially gone, cutting the Permanent Fund Dividend (PFD), the purpose of draining the Permanent Fund principal would be to continue to maintain overall state spending at current real levels without the need to implement taxes that would require the top 20%, non-residents and the oil companies to contribute significantly.
Of course, the effect would be the economic equivalent of heavy taxes on some. In the case of draining savings and the Permanent Fund principal, the burden of the approach falls hardest on future Alaska generations. As we’ve explained in previous columns, the burden falls hardest on middle and lower-income (80% of) Alaska families in the case of PFD cuts.
But throughout, at least up to the point at which the Permanent Fund principal is completely drained, the top 20%, non-residents, and the oil companies would largely escape, to borrow former Governor Jay Hammond’s phrase, “scot-free.”
Frankly, we are not surprised to see support for this proposal from Senator Bert Stedman (R – Sitka), Representative Bryce Edgmon (I – Dillingham), and others who previously have pushed using savings and when that ran its course, making PFD cuts to keep spending whole without requiring contributions from the top 20%, non-residents, and the oil companies.
But equally as frankly, we are shocked to see it coming from some, if not all, of the members of the Permanent Fund Corporation’s Board of Directors.
On its website, the Permanent Fund Corporation explicitly lists “protecting the assets… with which we have been entrusted” as one of its core “values.” Even at its most simple level – permitting the Legislature to continue to make annual POMV draws at 5% during extended periods when that is greater than the real (after inflation) rate of return earned by the Fund – the proposal the Board is considering would put the Permanent Fund’s core asset – the principal – at risk.
Indeed, with the proposal, the Board not only would fail to protect, but it would proactively be a party to targeting the Permanent Fund principal.
Increasingly, we are reminded of a situation with the former Alaska Public Utilities Commission (APUC) that ultimately came to a head during the 1999 legislative session.
Reflecting concerns that the APUC had wandered away from its intended purpose, the then-legislature decided to sunset the Commission and replace it with the Regulatory Commission of Alaska (RCA) – a new structure and membership designed to refocus the state’s regulatory activity in the area on its fundamental mission.
At least from our perspective, increasingly we are seeing a similar type of behavior from the Permanent Fund Board. The swerve into setting aside a portion of the fund for instate investments, the jerry-rigged accounting approach that understates available earnings, the proposed (by some) creation of an exception to the state’s open meetings act to permit the Board of a public corporation to operate outside public scrutiny, and the discussion of redirecting the fund toward increasingly risky (and potentially, debt-funded) investments all seem to be moving the Board – and Fund – farther and farther from its intended, if somewhat boring, purpose – the careful generation of earnings for the benefit of both current and future Alaska generations.
To us, sunsetting the Board and creating a new governing body would provide an opportunity to achieve several needed improvements.
For example, it could help depoliticize and professionalize the Board by establishing an appointment process along the lines suggested by long-time Permanent Fund advocate Larry Smith in a recent letter to the editor published in the Anchorage Daily News.
In another area, new authorizing legislation could help untangle the corporation’s current accounting approach for the earnings reserve.
The legislation also could help assuage the Board’s concern about inflation-proofing by providing that the payments will always be made at the same percentage of the statutory requirement as are directed to the equally statutory PFD.
But perhaps most importantly, a restart could help curb the potential descent by this and future Boards into either politically driven or financially risky investment strategies by establishing some basic investment standards. We are not suggesting, although some might, going all the way back to the old “legal list” approach, but we are suggesting focusing the board on an investment strategy that doesn’t create artificial in-state programs, “borrow money in order to invest,” or “put more money into high-risk, high-reward investments.”
As James Brooks summarized the comments of Permanent Fund Executive Director Deven Mitchell and Board Chair Ethan Schutt in a recent article, the latter two strategies just “increase the volatility of the fund’s performance,” but “in the end, the results could even out.”
In other words, as part of sunsetting the current board and establishing a new one, the Legislature could provide clear direction that the goal is not to stretch for earnings at any cost but to provide a relatively stable and safe stream of earnings for the benefit of both current and future Alaska generations.
We understand that might not produce an earnings stream that could occasionally prove sufficient to close the state’s fiscal deficit on its own. But it would produce a safe, secure, and steady stream of earnings sufficient to help regularly contribute significantly to that effort. As in any other state, the Legislature and governor would need to look to a combination of contributions from Alaskans, non-residents, and industry, as well as some spending restraint to help close the remainder.
In short, in our view, this proposal – and the Board’s apparent support for it – confirms that the current Permanent Fund Board has gone way off-track. The proposal should be stopped dead in its tracks, and, based on recent actions, the Legislature should begin to consider whether the current structure of the Board should be sunset and a replacement put in its place.
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.