Don't look now, but Alaska faces an enormous 2019 budget battle

Some of the candidates for governor and the Legislature don't realize it yet, but the next Legislature will be dominated by a budget battle that could be even more contentious than those of the past few years.

Because of all the campaign promises and a law passed this year, the political focus on the Permanent Fund Dividend will be greater than ever.

Elected officials will have to say how the Permanent Fund fits into the state budget and engage in the never-ending arguments about taxes, spending cuts, deficits and the instability of oil prices. The need for a long-range outlook may get lost in the process.

The problem with our politics in Alaska is that many candidates want to talk about the dividend as if nothing else matters, but all of them know that is not true. Many get away with it because they try to please their most vocal constituents.

The financial analysts who work for the Legislature have compiled a 10-page report that outlines the current budget dilemma for Alaska.

First off, to keep state services stable in the next fiscal year, the Legislature will need to increase general fund spending by about $200 million.

This is because some programs were intentionally underfunded to appear to keep the budget down, which is an old trick. Others were funded with pots of money that can't be duplicated and would have to come out of the general fund next time around. Still others are unavoidable cost increases, such as an estimated $38 million increase in retirement contributions.

Stepping back a bit, the Legislature laid the groundwork for the next enormous budget battle this year when it approved SB 26, a measure that for the first time uses some earnings of the Permanent Fund to help pay for state government.

Most of the Republicans in the Senate supported it, while most Democrats and several Republicans backed it in the House, but in both parties there are deep divisions.

Some Republicans want to cut the dividend to avoid taxes. Some Democrats want taxes to avoid dividend cuts. In neither party is there a single point of view.

The new law is a reasonable one that recognizes that the state's largest source of income is no longer oil, but investments in the $65 billion Permanent Fund. It makes good sense to use some of that money to help run the government because oil is no longer enough.

Under the new law, the Legislature and governor decided to take what could be a sustainable percentage from the Permanent Fund to pay for state government and dividends.

The law allowed for $2.7 billion to be spent from the Permanent Fund earnings this fiscal year, with about $1.7 billion of that amount going to pay for government. The deal was to set the dividend this year at $1,600.

But the law did not deal with how dividends will be decided in the future.

Close to half of the state budget will be funded by Permanent Fund earnings, while about 40 percent will come from oil and the rest from the Constitutional Budget Reserve. (If oil prices remain where they are today, the amount from oil will increase and the amount from reserves will drop or disappear.)

The law did not change the statutory formula established in the 1980s. That law remains in place and is bound to be a flashpoint in 2019.

The legislative compromise to pay $1 billion in dividends this year and the campaign rhetoric that oversimplifies Alaska's financial challenge means that the battle over dividends is not going away anytime soon.

I think the legislative analysts are correct in predicting that the "lack of clarity/consistency in SB 26 is almost certain to be the primary issue of the 2019 legislative session." The big controversy unaddressed in SB 26 was about the size of future dividends.

If the governor and Legislature follow the existing PFD formula in the law for dividends, that would increase the cost of dividends by about $900 million and reduce the amount available for government services. It would put the cost of the dividend at nearly $2 billion. The amount per person would rise to about $3,500.

It would also mean shortfalls of $1.4 billion to $1.8 billion a year though 2027, according to the current revenue forecast. If oil prices, now running higher than the forecast, remain that way, the shortfalls would shrink.

If oil prices retreat by $10 or $15 a barrel, which is easy to imagine, the fiscal problem explodes back to $1 billion or more.  "The fiscal model breaks down under these circumstances," legislative analysts say.

That's because the budget reserve to fill the deficits would be gone by fiscal year 2021 and the new law places a percentage limit on what can be withdrawn from the earnings reserve of the Permanent Fund.

"There would be no way to fill deficits without increasing revenue or reducing expenditures," the legislative report concludes.

The third option would be to increase the amount withdrawn from Permanent Fund earnings, which means the fund would be smaller in the future.

I suspect that there will be constant pressure in the years ahead to forestall taxes by arguing for an increase in annual withdrawals, justified by arguments that it will be temporary. Such actions are hard to reverse and could have long-range implications.

Changing the dividend formula so that it is based on 50 percent of the current amount allowed to be withdrawn from the Permanent Fund earnings would cut dividends by about $1,000 per person to $2,500. It would also mean a deficit of $800 million to $1.1 billion a year, based on current oil revenue projections.

To balance the budget without tax increases or spending cuts, dividends would have to be about 25 percent of the allowable percent of market value draw from the Permanent Fund, legislative budget analysts believe. That would mean a dividend of about $1,250 per person.

The arguments now and those to come about the dividend cannot take place is isolation from those about taxes, spending and the future of Alaska. Any candidate who says otherwise is not telling the truth.