Thursday, January 25, 2018

Is the current formulation of the PFD what Governor Hammond intended?

As we spend more and more time on the issue, increasingly we are coming to the view that the current formulation of the PFD is not entirely as Governor Hammond intended, once the state starts taking its "other half" of the earnings stream.

Here is what Governor Hammond said in Diapering the Devil, a book which, while published posthumously, was taken from manuscript and notes he had been working on before his passing and is consistent with his earlier writings in other books on fiscal policy.

The first relates to the creation of the Permanent Fund itself (at p. 15):
I wanted to transform oil wells pumping oil for a finite period into money wells pumping money for infinity. …
The second focuses on what to do with the earnings, once the “money wells” were pumping (at p. 19):
Each year one-half of the account’s earnings would be dispersed among Alaska residents …. The other half of the earnings could be used for essential government services.” 
Given the backdrop of how Alaska's mineral interests are owned, the so-called 50/50 split makes sense and is one we have -- and will continue to -- defend strongly on these pages.

But that is not entirely how the current formulation of the PFD works.

Instead, using FY 2016 numbers (the last year the Governor or the legislature didn't override the current statute), this is how the current statute (AS 37.13.145) operates:
  • Overall earnings (5-year average): $2.746 B
  • PFD: $1.373 B (50%)
  • Retained in the Earnings Reserve Account (i.e., the state's share): $0.749 (27%)
  • "Inflation proofing" (i.e., returned to the corpus): $0.624 B (23%)
As noted, under the current formulation the state's share was only 27% of the earnings stream, not the "other half" envisioned by Governor Hammond.

The reason for the shortfall is that, under the current statute, the portion used for "inflation proofing" -- purportedly the amount necessary to keep the Fund whole against inflation -- is taken entirely from the "other half" of the stream, instead of being divided equally between the "residents'" share and the "state's" share.  As we wrote on these pages in November, we believe inflation proofing benefits both sides (residents and state) of the split, and thus, should be borne equally. See "Notes from the Alaska Fiscal Cliff: Our Proposed Fiscal Solution" (Nov. 2017).

Before the past two years the fact that the split wasn't entirely as envisioned by Governor Hammond didn't make much of a difference.  Because the state wasn't using it's share of the split anyway, there really wasn't any significant, current harm from the way that the statute operated.  It simply took some of the state’s share and transferred it to Permanent Fund principal, not a bad place for surplus earnings.

Now that the state is beginning to take a share of the earnings, however, the formulation of the statute does make a significant difference. It reduces the state's share substantially below the "other half" envisioned by Governor Hammond.

As we also wrote in our November piece, we believe that the current inflation proofing formula overstates the current costs of inflation and should be revised as well.  We believe that a POMV approach could be a good solution to that (as long as the resulting earnings available for distribution continue to be split 50/50 between the private sector (residents) and state).

But that is a secondary point.  The primary point is that, even if inflation proofing is reduced to a more appropriate level and works perfectly, the current statute still won't reflect Governor Hammond's 50/50 split because all of whatever portion is set aside for inflation proofing comes from the state's share.

As we approach implementing Governor Hammond's full vision -- splitting the use of earnings from the state's "money wells" evenly between the private sector (residents) and state government -- we believe it's important to ensure that the split is done right.

For that reason, and as we outlined in our November piece, we favor making changes to the statute both to revise the manner in which inflation proofing is calculated and to ensure that the resulting transfers to the principal are shared equally between the residents' 50% (the PFD) and the portion made available for state spending.

And for that same reason we also will oppose simply moving the current statute to the Constitution.  As we explain above, once the government starts taking its share of the earnings the current statute doesn't fully achieve Governor Hammond's original intent.  Until it is corrected we believe locking that approach into the Constitution would be a significant mistake.