The earnings of the Permanent Fund are once again under discussion as the state looks at its fiscal problems. Using Permanent Fund earnings needs to be carefully thought through, as it presents a risk not only to the Permanent Fund dividend but also to the future of the Permanent Fund itself. This is because two of the most important protections for the fund — dividends based on performance and inflation-proofing — are in trouble.
Over decades the dividend has been critical to the success of the Permanent Fund. The size of the dividend rose or fell as a result of investment performance, and as a result there has been great support for the investment success of the fund. The direct link between investment performance and dividend size has been one of the core reasons that the Permanent Fund has had the political support to steadily follow prudent investment principles. Today, however, that link is much more in jeopardy. The dividend is half the amount of the prior year, and last year its size was not determined by investment returns but instead by the budget veto process.
A second key to the long-term success of the fund has been its inflation-proofing program, which protects the value of the Permanent Fund from the eroding effects of inflation. The Alaska Constitution prohibits spending the principal of the fund but, because it does not address inflation, leaves open a door through which the principal can be eroded by inflation. Last year for the first time since the startup years there was no appropriation for inflation-proofing. Failing to protect against inflation has an effect on the fund just as real as spending down the principal. If inflation-proofing had not been part of the Alaska Permanent Fund program over the years since the early 1980s, and that inflation-proofing money had been spent instead, the principal of the fund would be about $19 billion smaller than it is today.
A consistent set of measures for protection of both the fund and the dividend would have several elements: that there be a meaningfully sized dividend distribution to the public, that the amount of the dividend be linked to the investment performance of the fund, and that any use of earnings, including the dividend, be sustainable (where "sustainable" means not exceeding what the Permanent Fund can earn on average, above and beyond inflation).
The outcome from last year is inconsistent with the above points. Finding a budget solution pitted (1) new or higher taxes against (2) cuts to the operating budget against (3) using the Permanent Fund's earnings. Last year's spending drew heavily on reserves, but among the three mentioned above, the one that gave the most was Permanent Fund earnings, at the expense of both dividends and inflation proofing.
Also, in the process something else important happened: The size of the dividend was uncoupled from investment performance. Whenever the size of the dividend is simply a matter of legislative appropriation, or gubernatorial veto, or for that matter if it is simply set at a fixed dollar amount, then the size of the dividend is no longer linked to investment performance.
Uncoupling the size of the dividend from investment performance presents a dangerous situation: it becomes possible to propose a substandard investment (possibly one that is popular or has a powerful constituency) to be made by the Permanent Fund Corporation, and, at the same time, argue that making the investment won't affect anybody's dividend. A scenario like that can put tremendous pressure on the fund and if such a proposal ever gets through, it could mark the beginning of a reversal from the fund's great history of good performance. Over time, if there is no connection between investment performance and dividend size, it's an outcome just waiting to happen.
A similar threat comes from doing away with inflation-proofing: the effects might not be noticeable right away, but over time the erosion of value will be meaningful.
It is time to consider whether the Alaska Constitution should be amended to bolster the Permanent Fund so that the process doesn't chew it up. The heart of the amendment would provide for a significant dividend program whose size is linked to the investment performance of the fund, and protection of the fund against inflation.
The Permanent Fund has for years targeted earning 5 percent in excess of inflation. Inflation-proofing will happen automatically if the fund uses a sustainable payout rule, such as a reasonable percentage-of-market-value annual payout. A constitutional amendment using a 5 percent payout rule, and prescribing half of the payout go to dividends, should restore the dividend to around $1700 to $1900 per year, a size which would then grow or fall in subsequent years depending upon investment performance. And, the half of the 5 percent payout that does not go to dividends would make available $1.2 billion or more toward the state's fiscal problems.
What might the revised constitutional language look like? In the example below, plain text is what already appears in the Alaska Constitution, language proposed to be deleted is shown as a strikethrough, and proposed new language is in bold type:
Article IX, Section 15. Alaska Permanent Fund
At least twenty-five per cent of all mineral lease rentals, royalties, royalty sale proceeds, federal mineral revenue sharing payments and bonuses received by the State shall be placed in a permanent fund, the principal of which shall be used only for
those income-producing investments specifically designated by law as eligible for permanent fund investments made according to the prudent investor rule. All income from A payout of five percent of the market value of the permanent fund, as determined at the end of each calendar year in accordance with generally accepted accounting principles, shall be available in the following year for two purposes: a dividend distribution to the residents of Alaska, and a deposit to the general fund. shall be deposited in the general fund unless otherwise provided by law. The percentage of the payout to be used for dividend distribution shall be 50%. No separate legislative appropriation shall be necessary for the dividend distribution.
Steve Rieger is a former Alaska state legislator and former member of the board of trustees of the Alaska Permanent Fund Corp. He lives in Anchorage.
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