Monday, August 27, 2012

A Sidebar: Why Alaska needs to save now ...

Since publishing another piece on this page -- Alaska Budget Cutting:  Its Not Rocket Science ..." -- some readers have asked why Alaskans should be concerned about achieving a "sustainable" budget.  They suggest that, like other states, as long as spending within a given year does not exceed the revenues received in the same year there is no cause for concern and the current budget levels do not need to be reduced.

That issue will be the subject of a longer piece upcoming in the near future, but I am publishing the short answer now, as a sidebar to the "Its Not Rocket Science" commentary, so that readers are provided with a basic understanding of the reason while they are reading the related piece.

Alaska is unlike other states in a number of respects, but most important for this purpose is that Alaska currently funds virtually its entire General Fund from a single, ultimately non-renewable source -- oil.  On the other hand, in one way or another all other states fund state government largely with "renewable" sources -- such as property, sales or income taxes.  Such sources are classified as "renewable" because they continue to produce a relatively stable, predictable income stream as long as there is property, sales made or people located in the state.

That is not the case with Alaska.  As oil production tapers off over time, so will state revenues.

That is why spending revenues as they come in does not work the same for Alaska as it does other states.  In other states, that approach does not impair their ability to maintain spending at relatively consistent levels into the future.  Because future revenue levels stay roughly the same, those states are able to spend up to current revenue levels without being concerned about adversely affecting future spending levels.

The outcome in Alaska is different.  Without committing a portion of the current revenue stream to savings, future spending levels will look much different than today.  Unless there is some offset to the revenue declines which occur as oil production declines, future spending levels will be vastly lower. 

The approach reflected in the ISER studies referenced in the commentary calculates the level of savings required today in order to avoid this result and, like other states, position Alaska to maintain a consistent level of government spending into the future. 

Basically, the approach takes the balance in all current savings accounts (e.g., the Statutory Budget Reserve, Constitutional Budget Reserve, the Permanent Fund and various other accounts) that Alaska has accumulated to date, combines that with the additional surpluses (over the "sustainable" spending level) anticipated in the next few years, and invests the total (what ISER refers to as the "nest egg") in the same way the Permanent Fund is currently. 

The future income stream from that investment results in balancing out the future shortfalls in revenue from oil.  In essence, the income stream from the nest egg serves as a renewable revenue stream and enables Alaska to maintain a consistent level of state spending indefinitely into the future.

Some have suggested that Alaska already has enough savings, in the Permanent Fund, to provide a stable revenue stream for the future, or that the legislature already is putting enough additional savings aside to achieve the same objective.  As the future piece will discuss in greater detail, neither assumption is true.  Without substantially increasing the level of savings -- to what ISER describes as "sustainable" levels -- the revenue available for future Alaska spending levels will be much lower than Alaskans experience today.

Key to achieving those future benefits is to begin protecting the nest egg now.  Any delay reduces the nest egg -- and diminishes the level of revenues that future Alaskans will have available to spend.  As a result, instituting spending caps at the sustainable level now is critical to maintaining renewable earnings in the future.  Without maintaining and building savings now there will be insufficient renewable earnings tomorrow to maintain the same standard of living as oil revenues continue to decline.