The deficit solution developing in the Alaska Legislature wouldn't fix the whole problem, but could take a significant bite out of it and soften the onset of the coming economic recession.
How this plays out politically will determine the severity of our economic shock. If the legislators don't go far enough — still a big if — they could still cause a lot of unnecessary economic damage.
On Wednesday, Senate Finance Co-Chair Anne MacKinnon, R-Anchorage, advanced legislation to change how the state uses earnings from the Permanent Fund, legislation also put forward in the House Finance Committee. The bills simplify Gov. Bill Walker's idea for reworking the fund, using the Percent of Market Value concept discussed for many years.
Since the early 1980s, the fund has paid out realized earnings — investment income and profits made in the sale of assets. That money goes to a Permanent Fund Earnings Reserve Account. Under the Alaska Constitution, the Legislature can spend money in the reserve account and has used it, with a set of formulas, for dividends and reinvestment to offset inflation.
This outdated system has a lot of problems. A better way, experts agree, is to take a set percentage of the fund annually, the Percent of Market Value, or POMV, leaving enough money behind to cover inflation in an average year. The set POMV also creates a more stable payout.
The fund's Board of Trustees began requesting a change to the POMV payout in 2000, but legislators didn't think it was popular with voters and didn't take action (in fact, voters didn't understand it). To do this right, we would have passed a constitutional amendment years ago for POMV and today's problem would be much simpler.
MacKinnon's concept would spend 5.25 percent of the market value of the entire fund, but would take the money only from the earnings reserve account (so that no change to the Constitution is needed). A fifth of that amount would go to dividends, as would 20 percent of the state's oil royalties. The rest of the POMV payout would be available to spend on the budget.
Inflation-proofing would end, but the fund would mostly keep up with inflation, depending on the inflation rate and the success of investments. Poor investment years could conceivably cause the earnings reserve to go dry, but that's not an immediate concern.
Essentially, the concept sweeps up inflation-proofing, half the dividend, and extra investment earnings and puts them all toward the budget. The bottom line cuts the $4 billion deficit to approximately $2 billion and reduces future dividends by about half, from $2,000 to $1,000, a level where they would stay.
This is a good start, but it is not enough.
First of all, as many have pointed out, a cut in dividends amounts to a head tax, which hurts the poor most. A graduated income tax would address that unfairness, but the Legislature probably won't even vote on one, unless the majority engineers an income tax vote merely to inflict political damage on minority members who would support it in a losing cause.
Secondly, a $2 billion deficit is still too large. It would consume savings rapidly and would signal to the economy the Legislature won't take care of business.
A recession is unavoidable as Alaska moves to a smaller economy with less oil money, said Gunnar Knapp, the director of the University of Alaska Anchorage Institute of Social and Economic Research. But uncertainty about a big remaining deficit has the potential to make the recession much worse.
That uncertainty affects everyone. Employees worry about their jobs, consumers hold off on purchases, banks examine loans more closely, the financial markets demand more interest on government debt, and businesses pull back on expansion plans.
"If a first-year school district employee came to a bank and said, 'Can I have a loan to buy a house?' what is the bank supposed to do?" Knapp said. "There's huge uncertainty at the university. Nobody at the university knows what's left. The problem isn't solved. The uncertainty isn't gone."
Ron Duncan, president and CEO of GCI, who helped mobilize a coalition of business and labor leaders to push for a solution, agreed in an email that a $2 billion deficit would be too large to reassure the private sector, because it would still exhaust savings. But if combined with cuts and taxes that get the deficit down to $1 billion, MacKinnon's proposal would "make a material difference."
More cuts may develop from the process. MacKinnon and other majority members want to use the Constitutional Budget Reserve to cover the deficit, which would require Democratic votes in the House. It's hard to imagine the minority going along with that vote as long as enormous expenditures for oil tax credits remain in the budget. Cutting those credits would also produce much of the needed savings.
The House majority signaled this week that it will approve three small tax increases Walker proposed, on fuels, mining and commercial fishing, worth a combined $65 million.
Some legislators have grasped at the hope that they don't need to finish the job this year. When MacKinnon introduced her plan Wednesday, Sen. Mike Dunleavy, R-Wasilla, said, "This is a two- and three-year process, to be honest with you. I don't think this is going to be done in seven days. And I don't think anyone realistically thinks we can do a comprehensive program in seven days."
Yes, that is an incredibly annoying statement, like a kid saying he can't start and finish a big school project in the hours left before bedtime the night before it is due.
But leaving aside that annoyance, we're in a better spot than it appeared we might be. If the Legislature wrestles the deficit down to $1 billion before leaving Juneau, we can have a legislative election next fall on how to cover the rest of that gap, knowing we have a couple of years of breathing room.
We're going to feel the cuts. Unless something unexpected happens, we will end up with more taxes. I hope the future taxes will make this solution more fair.
Charles Wohlforth's column appears three times weekly.
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