Monday, March 16, 2015

An exchange over the House budget vote ...

Last Thursday the House voted to adopt the House Finance Committee Substitute for this year's Operating Budget.  Assuming the Senate and any subsequent Conference Committee (if one is needed) concurs and the Senate and House reach the same bottom line as in the Governor's Capital Budget, the House Operating Budget will result in lowering state spending from this year's $6.32 billion (adjusted to include PERS/TRS), to $5.45 billion, a drop of nearly $900 million (or 14%).

I followed and wrote extensively on the budget as it proceeded through the House Finance Subcommittees and the full Committee.  The pieces are captured here and here.  Subsequent to the adoption by the full House of the Committee Substitute I also sent a note congratulating the House Finance Committee and Subcommittee Chairs on their work.

Subsequently, some have debated whether the work of the House went far enough, arguing that deeper cuts should have been made during the process.

As readers of these pages (or if not, readers of the notes referenced above) will know, earlier this year Dr. Scott Goldsmith published an update of the work he and others at the University of Alaska-Anchorage have done in the past on developing a "sustainable budget."  A sustainable budget is one which, based on Alaska's known and reasonably anticipated asset base, produces an annual level of revenue that can be sustained indefinitely into the future, adjusted for population growth and inflation, if each year the state limits spending to no more than the calculated amount.

In essence, a sustainable budget is an approach designed to provide all Alaskans, both this and future generations, an equal baseline level of state revenue, and at the same time provide a stable fiscal climate on which long-term investors can rely, both of which are critically important to a resource-drive state like Alaska.  In his analysis earlier this year, Dr. Goldsmith calculated that Alaska's current sustainable revenue level is $4.5 billion.

Those who have argued before and since the House vote that deeper cuts should have been made in the current budget point to the $4.5 billion as the target spending level toward which the House should have worked this session.  Since the proposed capital budget already is at minimal levels, to do that the House would have been required to reduce the Operating Budget by an additional $950 million, or by over 20% in total from current (FY 2015) levels.  Combined with the capital budget, achieving that objective would require a nearly 30% drop in state spending in one year.

In my notes to the House Subcommittee and Committee Chairs during the formulation process I congratulated them on taking an approach which is designed to achieve a sustainable budget in three years, by lowering overall spending to $5.5 billion in this legislative session, to $5 billion in the next and finally, $4.5 billion in the session which deals with the FY 2018 budget.  I and others who have worked extensively on these issues believe that is a reasonable approach given that the additional cuts will need to come from the Operating Budget, which is more complex and needs more detailed thought than making cuts to the capital budget.

(Recall that while a number of observers have seen the state's fiscal crisis coming for a number of years, many legislators only have faced up to the crisis since the precipitous fall in oil prices over the past nine months.  While disappointing, the consequence is that little had been done before the current legislative session to re-envision the Operating Budget around a smaller fiscal footprint.  That needs to be done before the deeper, additional cuts required to achieve sustainability are made in order to ensure that they are done efficiently and fairly.)

As noted, however, others have criticized the approach, most recently arguing that the drop in oil prices requires deeper cuts immediately.  While oil prices certainly matter, I believe that focusing entirely on and responding to them misunderstands the basis behind a sustainable budget and am concerned that some are now, overreacting to the drop by seeking steeper, immediate cuts to spending than responsibly can be accomplished on such short notice.

Yesterday, in one of the forums maintained to discuss these issues, I engaged in a a fairly lengthy exchange with one of those who believe the immediate cuts should be deeper.  I thought readers outside that forum might find it useful as well.

The full, extended exchange involving several participants is here.  A portion involving a discussion of why the recent drop in oil prices does not compel an immediate cut to the sustainable level is excerpted below.
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John Richard Myers We only needed six more votes to change the outcome. Which six pack of duds do we need to replace? We will have plenty of evidence to demonstrate their hypocrisy and unfitness to serve the people.


Brad Keithley Wait, John Richard Myers ... [during your recent campaign for Governor] didn't you advocate a phased approach as well?  ".. As Governor, my budget target will be lean and sustainable. I propose across the board spending cuts spread out over my first four years in office until we’ve achieved this goal."http://bgkeithley.com/.../guest-column-j-r-myers-the.../...

Publisher's Note:  From time to time as we approach...
BGKEITHLEY.COM

John Richard Myers Yes, but at this rate with the continued uncertainty of the oil markets, we will not reach our goal of a sustainable budget. I am concerned that our window of opportunity is about to slam shut. Then the mold will be cast and we will witness the folly unfold in rapid order.

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John Richard Myers I am advocating a reduction of the size of government based upon my belief that the state, like the feds, is engaged in activities beyond their legitimate scope of authority. The actual numbers may be a moving target, so we cannot say definitely what those should be. Though it is my understanding that it is now around 4.5 billion. Therefore the current budget which passed the house should have been cut twice as much as it was. Perhaps the Senate will dig a little deeper into the waste fraud, abuse and illegitimate activities. I oppose any further taxation via new statewide sales, income or property taxes or PFD raids. Revenue is not the whole issue. Deficit budgeting to support bloated government is it. I see little will to address this as aggressively as needed.

Brad Keithley Well, during the campaign, at a time when oil prices were already dropping, you advocated a four year transition. At the time the current spending level from which the transition was to occur was $6.2 billion, and the sustainable level $5 billion, which implied a $300 million per year cut. 

The current spending level is still $6.2 billion and the sustainable level $4.5 billion, which if we were to do the same four year transition as [you] earlier advocated (which would seem reasonable given that the necessary cuts are even larger than when you were advocating a four year transition before) would imply an annual cut of $425 million. If the legislature is able to hold the line this year at $5.5 billion, which members in HFIN worked hard to do against very strong headwinds, the actual cut this year will be $700 million, over twice what you advocated during the campaign and still greater than even updating your campaign position to reflect the current sustainable level. 


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Brad Keithley ... let me add a couple of facts to the discussion and see if that helps clarify our discussion. 

The #first is that under the ISER formula the price of oil is only part of the calculation of a sustainable budget number. As Scott [Goldsmith]'s most recent paper (http://goo.gl/VmAUnv) points out, the net present value of anticipated future oil and gas revenues ($68.8 B) only makes up roughly half of the current value of the state's nest egg. An almost equal share ($66.2 B) is made up of the state's financial assets. That means that while the drop in the price of oil has an effect on the sustainable budget level, it is not all determinative. The return the state realizes on its financial assets (and the level of those assets) plays virtually an equal role, and those returns have been higher than projected for the last few years. That does not mean that we should not be concerned about the price of oil, or that we always can count on the returns on the state's financial assets to make up the difference, but it does mean that we don't need to be running to the other side of the fiscal ship and arguing for deeper than reasonable cuts [in one year] simply because the price of oil is staying lower than anticipated. It is important to keep the broader picture continually in mind. 

The #second is that at a certain price level continued reductions in the price of oil don't make that significant a difference in state revenue levels. That is because the largest share of oil revenues comes from production taxes and once those stop being a significant factor (somewhere around $70) continued reductions, while they have some effect, aren't huge, especially when viewed on a net present value basis. Table A-1 of the Fall Revenue Sources Book (http://goo.gl/RKhgnF) illustrates the point. Between $100 and $90 state revenues fall nearly a $1 B. By the time you get down to $70, however, the difference (between $70 and $60) in state revenues is only $300 million and between $60 and $50, only $200 million. That means while there is some continued revenue loss from further drops in the price of oil, they are not equal to the revenue losses we have already incurred. Again, this is not to discount the importance of oil, but it helps explain further why I don't believe we need to be running immediately to the other side of the fiscal ship.

Frankly, while I had some concerns about the length (I think four years is too long), I think [you] ... had it right when [you] argued for a#transition to a sustainable budget. While the drop in oil prices (together with past overspending) has made the difference -- and resulting size of the steps -- bigger, it does not undermine the approach. Certainly if [you] thought that $300 million per year over 4 years was the right approach during the campaign, I don't see why $700 million this year, and $500 million the next two is not enough.

Which brings me to the #final point. As I said in another post, I don't mind someone arguing for and voting for a lower budget -- if they believe a faster transition is appropriate, that's fine. But I do mind when that is translated into the argument that all of the others -- those that worked hard on and voted for a transition approach -- did something wrong (to use J.R.'s phrase, engaged in "hypocrisy and unfitness to serve the people. ") There were people on HFIN who worked very hard to achieve the recent budget outcome. We need to keep in mind that they faced pressures not only to roll back the reductions those members made in subcommittee, but to roll back also the cuts Governor Walker had made in his proposal. They withstood all of that, continually driving toward a bottom line budget that met the first transition target. Having done what we asked -- indeed, what J.R. proposed in his campaign -- I think they deserve thanks and support, not vindication.