Tag Archives: Governor Walker

What’s going on with Alaska’s budget?

Alaska is facing another budget deficit this year – one of $3 billion – and many are skeptical that the process of closing this gap will be without hassle. The state faces declining oil prices and thinning reserves, forcing state legislators to rethink their previous budgeting strategies and to consider checking their spending appetites. This shouldn’t be a surprise to state legislators though – the budget process during the past two years ended in gridlock because of similar problems. And these issues have translated into credit downgrades from the three major credit agencies, each reflecting concern about the state’s trajectory if no significant improvements are made.

Despite these issues, residents have not been complaining, at least not until recently. Every fall, some earnings from Alaska’s Permanent Fund get distributed out to citizens – averaging about $1,100 per year since 1982. Last summer, Governor Walker used a partial veto to reduce the next dividend from $2,052 to $1,022. Although politically unpopular, these checks may be subject to even more cuts as a result of the current budget crisis.

The careful reader might notice that Alaska topped the list of the most fiscally healthy states in a 2016 Mercatus report that ranks the states according to their fiscal condition (using fiscal year 2014 data). For a state experiencing so much budget trouble, how could it be ranked so highly?

The short answer is that Alaska’s budget is incredibly unique.

On the one hand, the state has large amounts of cash, but on the other, it has large amounts of debt. Alaska’s cash levels are what secured its position in our ranking last year. Although holding onto cash is generally a good thing for state governments, there appears to be diminishing returns to doing so, especially if there is some structural reason that makes funds hard to access for paying off debt or for improving public services. It is yet to be seen how these factors will affect Alaska’s ranking in the next edition of our report.

Another reason why Alaska appeared to be doing well in our 2016 report is that the state’s problems – primarily spending growth and unsustainable revenue sources – are still catching up to them. Alaska has relied primarily on oil tax revenues and has funneled much of this revenue into restricted permanent trusts that cannot be accessed for general spending. When the Alaska Permanent Fund was created in the 1980s, oil prices were high and production was booming, so legislators didn’t really expect for this problem to occur. The state is now starting to experience the backlash of this lack of foresight.

The first figure below shows Alaska’s revenue and expenditure trends, drawing from the state’s Comprehensive Annual Financial Reports (CAFRs). At first look, you’ll see that revenues have generally outpaced spending, but not consistently. The state broke even in 2003 and revenues steadily outpaced expenditures until peaking at $1,266 billion in 2007. Revenues fell to an all-time low of $241 billion following the recession of 2008 and then fluctuated up and down before falling drastically again in fiscal year 2015.

alaska-revenues-exp4.5.17

The ups and downs of Alaska’s revenues reflect the extremely volatile nature of tax revenues, rents, and royalties that are generated from oil production. Rents and royalties make up 21 percent of Alaska’s total revenues and oil taxes 6 percent – these two combined actually come closer to 90 percent of the actual discretionary budget. Alaska has no personal income tax or sales tax, so there isn’t much room for other sources to make up for struggling revenues when oil prices decline.

Another major revenue source for the state are federal grants, at 32 percent of total revenues. Federal transfers are not exactly “free lunches” for state governments. Not only do they get funded by taxpayers, but they come with other costs as well. There is research that finds that as a state becomes more reliant on federal revenues, they tend to become less efficient, spending more and taxing more for the same level of services. For Alaska, this is especially concerning as it receives more federal dollars than any other state in per capita terms.

Federal transfers as an income stream have been more steady for Alaska than its oil revenues, but not necessarily more accessible. Federal funds are usually restricted for use for federal programs and therefore their use for balancing the budget is limited.

A revenue structure made up of volatile income streams and hard-to-access funds is enough by itself to make balancing the budget difficult. But Alaska’s expenditures also present cause for concern as they have been growing steadily, about 10 percent on average each year since 2002, compared with private sector growth of 6 percent.

In fiscal year 2015, education was the biggest spending category, at 28% of total expenditures. This was followed by health and human services (21%), transportation (11%), general government (10%), the Alaska Permanent Fund Dividend (9%), public protection (6%), and universities (5%). Spending for natural resources, development, and law and justice were all less than 5 percent.

The next figure illustrates the state’s biggest drivers of spending growth since 2002. Education and general government spending have grown the most significantly over the past several years. Alaska Permanent Fund spending has been the most variable, reflecting the cyclical nature of underlying oil market trends. Both transportation and health and human services have increased steadily since 2002, with the latter growing more significantly the past several years as a result of Medicaid expansion.

alaska-spendinggrowth4.5.17

Alaska’s spending is significantly higher than other states relative to its resource base. Spending as a proportion of state personal income was 31 percent in fiscal year 2015, much higher than the national average of 13 percent. A high level of spending, all else equal, isn’t necessarily a bad thing if you have the revenues to support it, but as we see from this year’s budget deficit, that isn’t the case for Alaska. The state is spending beyond the capacity of residents to pay for current service levels.

What should Alaska do?

This is a complicated situation so the answer isn’t simple or easy. The Alaska government website provides a Microsoft Excel model that allows you to try and provide your own set of solutions to balance the budget. After tinkering with the state provided numbers, it becomes clear that it is impossible to balance the deficit without some combination of spending cuts and changes to revenues or the Permanent Fund dividend.

On the revenue side, Alaska could improve by diversifying their income stream and/or broadening the tax base. Primarily taxing one group – in this case the oil industry – is inequitable and economically inefficient. Broadening the base would cause taxes to fall on all citizens more evenly and be less distortive to economic growth. Doing so would also smooth revenue production, making it more predictable and reliable for legislators.

When it comes to spending, it is understandably very difficult to decide what areas of the budget to cut, but a good place to start is to at least slow its growth. The best way to do this is by changing the institutional structure surrounding the political, legislative, and budgeting processes. One example would be improving Alaska’s tax and expenditure limit (TEL), as my colleague Matthew Mitchell recommends in his recent testimony. The state could also look into item-reduction vetoes and strict balanced-budget requirements, among other institutional reforms.

Ultimately, whatever steps Alaska’s legislators take to balance the budget this year will be painful. Hopefully the solution won’t involve ignoring the role that the institutional environment has played in getting them here. A narrow tax base reliant on volatile revenue sources, restricted funds, and growing spending are all factors that have led many to think that Alaska is and always will be “different.” But what constitutes sound public financial management is the same regardless of state. Although Alaska’s situation is unique, their susceptibility to fiscal stress absent any changes is not.

States Look to Rainy Day Funds to Avoid Future Crises

For the past nine quarters, state revenue collections have been increasing and are now approaching 2008 levels after adjusting for inflation. Many state policymakers are no longer facing the near-ubiquitous budget gaps of fiscal year 2012, but at the moment those memories seem to remain fresh in their minds.

Many states are looking to rainy day funds as a tool to avoid the revenue shortfalls they have experienced since the recession. In Wisconsin, for example, Governor Walker recently made headlines by building up the states’ fund to $125.4 million. In Texas, the state’s significant Rainy Day Fund has reached over $8 billion, behind only Alaska’s fund that holds over $18 billion.

A June report from the Tax Foundation shows Texas and Alaska are the only states with funds that are significant enough to protect states from budget stress in future business cycle downturns. As the Tax Foundation analysis explains, state rainy day funds can be a useful to smooth spending over the business cycle. Research that Matt Mitchell and Nick Tuszynski cite demonstrates that rainy day funds governed by strict rules about when they may be tapped do achieve modest success in smoothing revenue volatility. Because most states have balanced budget requirements, when tax revenues fall during business cycle downturns, states must respond by raising taxes or cutting spending, both pro-cyclical options. If states are required to contribute to rainy day funds when they have revenue surpluses and then are able to draw on these savings during downturns in order to avoid tax increases or spending cuts, this pro-cyclical trend can be avoided.

The Texas Public Policy Foundation points out some of the benefits of large rainy day funds:

Maintaining large “rainy day” funds  benefits Texas and Alaska in three ways:

1) These states do not rely  on large pots of one-time funding to pay for ongoing expenses, but rather balance their books by bringing spending in line with revenues;

2) These states  have reserves on hand to deal with emergencies; and

3) Having a large “rainy day” fund improves the states’ bond rating which means lower interest rates for borrowing.

However, even as more states begin making significant contributions to their rainy day funds, they have not fulfilled their pension obligations. According to states’ own estimates of their pension liabilities, states’ unfunded pension liabilities total about $1 billion. However using private sector accounting methods, states are actually on the hook for over $3 trillion in unfunded pension liabilities. Because states do not use the risk-free discount rate to value these liabilities, the surpluses they think they have to contribute to rainy day funds are illusions.

Even if states were already contributing appropriately to their pension funds and systematically contributed to rainy day funds during revenue upswings, it’s not clear that rainy day funds are a path toward fiscal discipline.  Because of the perpetual tendency for government to grow, it’s unlikely that state policymakers will take any steps to reduce the growth of government during times of economic growth. If states successfully save tax revenues in rainy day funds to avoid having to make spending cuts during recessions, states will not have to decrease spending at any point during the business cycle. States’ balanced budget requirements can provide a mechanism that helps states cut spending in some areas when revenues drop off, but rainy day funds obviate this requirement. Successful use of rainy day funds could contribute to the trend of states’ spending growing fast than GDP.

Supporters of substantial rainy day funds should acknowledge that these cushions — which on the one hand may provide significant benefits to taxpayers — come at the expense of cyclical opportunities to cut the size of state governments to bring them in line with tax revenues. Without the necessity of cutting spending at some point, state budgets might grow more rapidly that they already are, hindering economic growth in the long run. Whether or not rainy day funds increase the growth rate is an empirical question that advocates should research before recommending this strategy, and this possible drawback should be weighed against their potential to reduce revenue volatility.