Alaska Council for Economics Education: Economics spring forum (4.6.2016)

Perspectives on Alaska’s Budget

2016 Economics Spring ForumApril 6, 2016

Brad Keithley (bgkeithley.com)President, Keithley Consulting, LLCFounder, Alaskans for Sustainable Budgets

Agenda …

• 5:00 – 6:30: “Three key points” (and a little bit about oil economics)

• 6:30 – 6:50: Break• 6:50 – 8:00: Questions & some current issues

Presentation at http://www.slideshare.net/bgkeithley/

April 6, 2016 Alaskans for Sustainable Budgets 2

Three Key Points• Alaska is facing a budget challenge, but how big is it • There is a solid and realistic fiscal alternative that doesn’t rely on PFD cuts or taxes

• In my view, the Permanent Fund “replumbing” proposals • Are unnecessary, • Are imbalanced (between the private and government sectors),

• Do more harm than good to the overall Alaska economy, and

• Undermine the “permanence” of the Permanent Fund

April 6, 2016 3Alaskans for Sustainable Budgets

First Point

Alaska is facing a budget challenge, but how big is it


There is a challenge…


… but how big is it?

April 6, 2016

If assumptions are …• $80/bbl by FY 2020 (v.

FY 2022)• 3% production decline

(v. 5%)• New oil, #AKLNG & use

of PFER• Population growth of

0.5% (v. 1%), then… long term sustainable revenue is $4.3B (w/o PFD cut or taxes)

6Alaskans for Sustainable Budgets

A quick note on why I use the Goldsmith model …

• Determines a long‐term “sustainable” revenue/budget number based on a multi‐year forward look – not a year‐to‐year approach.

• Enables adjustments to key inputs (oil price & production, LNG, population growth, POMV rate). Why needed?"The reason the Department of Revenue will invariably always project declining oil production is because of the relatively conservative nature by which production forecast occurs … [I]t is 'highly likely' that the State will see increased production of 50,000 barrels per day [and] a further 50,000 barrels is considered 'likely' by DOR and the Department of Natural Resources.“ ‐ AG Craig Richards (Feb 2016)


“But what if” …AKLNG (% chance of success):

75%: $4.1 billion50%: $3.9 billion25%: $3.7 billion0%: $3.5 billion

Oil price (by 2020):$70: $4.1 billion$60: $3.9 billion

Oil decline at:4%: $4.2 billion5%: $4.1 billion

April 6, 2016

Or a combination …AKLNG (75%), Oil ($70), Decline (4%): $3.8 billionAKLNG (50%), Oil ($60), Decline (5%): $3.3 billionAKLNG (0%), Oil ($50), Decline (6%): $2.8 billion

Or … AKLNG (100%), Oil ($80), Decline (1%): $4.6 billion

The point is … use the best available information at the time


What crude price …


Best information at this point …Oil ($80 by 2020): “The process of adjustment in the oil market is rarely a smooth one, but, in our central scenario, the market rebalances at $80/bbl in 2020, with further increases in price thereafter.” (World Energy Outlook, International Energy Agency, Nov. 2015)

Production (3% decline): “Repsol and Armstrong have said the project could yield up to 120,000 barrels daily. That estimated rate is not “unreasonable" based on details that have been published about the project, said Mark Myers, Natural Resources commissioner and a former head of the U.S. Geological Survey.” (Alaska Dispatch News, Feb. 15, 2016)

LNG (~2025): At a time of historic capital constraint, at least two of the largest LNG companies – and most sophisticated investors –in the world are planning to continue to invest.


The oil cycle: investment …


The oil cycle: supply & demand…


The oil cycle: looking forward …


“Since the oil price collapse in 2014 … 68 major projects containing 27 billion boe, equating to US$380 billion of capex“ have been deferred –Wood Mackenzie (January 2016)

The concern … •We are formulating fiscal policy projecting out from the bottom of a commodity cycle … … and as a result may be assuming we need to raise more “new” revenue than necessary when looked at from a long term perspective… in short, the reverse of the overspending problem we experienced from 2011‐14 (when the Gov & Legis assumed oil would rise forever)

• Alaska is a commodity based economy and as a result needs to take a long term budget view, not a one year snapshot


Second Point

There is a solid and realistic fiscal alternative that doesn’t rely on PFD cuts

or taxes


Core Principles …

• Use an approach that looks at the full commodity cycle and develops a balanced, sustainable approach that smooths through the revenue highs and lows

• Don’t cut the PFD or impose other taxes if avoidable because of impact on Alaska’s private economy – and if not avoidable, only to the extent it does not harm the overall Alaska economy (in short, don’t overreact)


ApproachBest approach remains Goldsmith model

Keys• Set spending at long‐term sustainable levels based on best reasonable long‐term forecast

• Use the Permanent Fund earnings reserve – the part remaining after PFD and inflation proofing – to act as the balancing mechanism

• Remain alert to changes in key, long‐term forecast variables and adjust levels if there are significant, long‐term changes


Revenues

April 6, 2016

If assumptions are …• $80/bbl by FY 2020 (v.

FY 2022)• 3% production decline

(v. 5%)• New oil, #AKLNG & use

of PFER• Population growth of

0.5% (v. 1%), then… long term sustainable revenue is $4.3B (w/o PFD cut or taxes)


Spending Cuts

April 6, 2016

FY 2016 compared to FY 2006 adjusted for inflation and population growth …


We have done it before …

April 6, 2016 20

FY 95 – 06 real spending was significantly lower …

FY 1995 ‐ 2006

Alaskans for Sustainable Budgets

Where are we now …


Critical: A spending cap …

• Starting point: HB 311“An Act requiring the governor's fiscal plan to include certain information”

• Reworked, could be used either as a statutory spending cap or as a substitute for Const. Art 9, Sec. 16 (“Appropriation Limit”)


Third PointThe PFD “replumbing” proposals (SB 128, SB

114 and HB 224):• Are unnecessary, • Are imbalanced (between the private and government sectors), • Do more harm than good to the overall Alaska economy, and • Perhaps most importantly, undermine the “permanence” of the Permanent Fund


Unnecessary• If the long‐term sustainable revenue level is ~$4.3 billion – and we can cut spending to that level – do we need to be adding revenue?

• Until we have a better feel for where long‐term oil and gas markets are headed, there is no compelling case for long‐term PFD cuts and taxes (i.e., overreacting)


SB 128 and SB 114

April 6, 2016

PFD Cuts

Spending Cuts

Tax + PFD Cuts

SB 128 and SB 114 are imbalanced between spending (gov’t sector) and PFD (private sector) cuts …


HB 224 (Hawker)

April 6, 2016 26

Why cut the PFD? Hawker: “Direct, indiscriminate redistribution of [the PFD], from the resource to people … that is pure socialism,” he said. “It’s confiscating wealth and redistributing it without any public purpose, and that’s just simply wrong.”

Alaskans for Sustainable Budgets

Need to consider overall economy

“[M]ost of the cash from dividends will ultimately find its way into the Alaska economy to increase employment, population, and income. … [If the dividend instead had been diverted to state government,] the most likely alternative use of the PFD would probably have been to increase capital spending by state government. … Capital spending would have generated less employment and increased income inequality.” ‐‐ Dr. Scott Goldsmith (2010, looking back on prior experience)

April 6, 2016

PFD cuts could do more harm than good …


If new revenues are required, taxes do less harm than PFD cuts…

“Reducing dividends to produce the same amount of revenues as would the proposed income tax would actually cost Alaska more jobs and income than would re‐imposing an income tax ….” – Dr. Scott Goldsmith (1987)

April 6, 2016

“… Alaskans are more likely to spend the Permanent Fund dividends …; almost all of the dividend money is paid to persons actually living in Alaska; and Permanent Fund dividends are generally taxed at a lower rate …”


March 2016 ISER Analysis


Institute of Social and Economic Research, “Observations on Alaska’s Economy and Economic Implications of Alaska’s Fiscal Choices,” March 31, 2016

Undermines the Permanent Fund• From the start, the PFD was designed to protect the permanence of the Fund itself:“I wanted to encourage contributions into the investment account and to protect against its invasion by politicians by creating a militant ring of dividend recipients who would resist any such usage if it affected their dividends.”

– Jay Hammond, Diapering the Devil

• The “replumbing” bills delink the PFD from the Fund, creating affirmative financial incentives for Alaskans to draw from the Fund (e.g., avoid taxes)

• Effectively makes the Fund the “new” CBR


My point … • The proposals are imbalanced: They take much more from the private sector – through PFD and taxes – than they cut spending

• While they help the government economy, it comes at the expense of Alaska’s overall economy, which at $40 oil is rapidly developing its own problems

• Perhaps most importantly from a long term perspective, they undermine the “permanence” of the Permanent Fund


Three Key Points• Alaska is facing a budget challenge, but it may not be as big as some suggest

• There is a solid and realistic fiscal alternative that doesn’t rely on PFD cuts or taxes

• SB 128 (Governor), SB 114 (McGuire) and HB 224 (Hawker) are unnecessary, are imbalanced (between the private and government sectors), do more harm than good to the overall Alaska economy, and undermine the “permanence” of the Permanent Fund

If all else fails, a repeal referendum this fall on any PFD bill

#ProtectThePFD


Q&A and some current issues …• Oil & gas tax credits• The Senate’s $100 MM hole:

• Shifting some costs down (PERS, TRS, Alaska Performance Scholarships & Revenue Sharing)

• Medicaid Reform• Criminal Justice Reform

• Other revenue options• Rep. Olson’s 35% PFD “tax” (4‐year “stopgap measure”)• The minor taxes• Sen. Micciche’s “sunset” provisions

• Others?


For More Information …

Thought on Alaska Oil & Gasbgkeithley.com

Michael Dukes ShowTuesdays at 7:15am

kbyr.com


News & Politics

Alaska Council for Economics Education: Economics spring forum (4.6.2016)