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Missing the Point

The views expressed herein are the author's alone and do not represent those of Alaska Business Monthly.

At the time this piece publishes, those seeking signatures on petitions to hold a referendum to overturn SB21, the governor’s oil tax reform bill, will be in the final days of their effort. If they succeed, a long campaign of more than a year will follow on the issue, with a vote scheduled for the August 2014 primary ballot.

At least at an early stage, most observers expect the petition drive to succeed in gaining enough signatures to put the issue on the ballot. The issue will not go away, however, even if the backers of the referendum effort fail in those current efforts.

Early indications are that the wisdom of the Administration’s bill likely will play a central role in the anticipated Republican primary battle next year between Governor Parnell and challenger Bill Walker, and thereafter in every contested race in the 2014 legislative elections.
Even beyond that, we should anticipate frequent comments on the issue—and occasional, if not regular efforts to repeal or modify it—as legislators and others debate beyond the 2014 elections whether the bill is succeeding in its central purpose to increase North Slope production above levels which otherwise would have resulted under “Alaska’s Clear and Equitable Share” (ACES), the state’s previous tax approach.

The Arguments
To this point, a central theme of the referendum effort has been that SB21 will have devastating consequences to state government finances, resulting in cuts to education and capital budget spending on which, at least according to one Senator, the Alaska economy “depends.” The petition drive’s initial sponsor, former Republican legislator Ray Metcalfe, even has gone so far as to suggest that the passage of SB21 ultimately will result in cuts in the Permanent Fund Dividend, the sacred third rail of Alaska politics (similar to social security at the federal level).

Both by implication and explicitly, the proponents of the referendum argue that these cuts will not occur if Alaskans repeal SB21 and retain ACES.

For their part, the legislation’s defenders have claimed the reverse, arguing that SB21 somehow will save current state spending levels. Indeed, as discussed further below, Governor Parnell has gone so far as to outline a five-year fiscal plan which depends on such a result—and puts future Alaskans at significant financial risk if the legislation does not achieve that objective.

Unfortunately for Alaskans, both sides are wrong.

At current spending levels, ACES leads Alaska over a fiscal cliff as certainly as its proponents argue does SB21. From the other side, defenders of SB21 are required to rely on heroic—and viewed fairly, unreasonable—assumptions to support assertions that the legislation justifies continued state spending at current levels. Even if the legislation achieves all that its supporters hope, the most likely scenario is that it still will fall far short of buttressing a continuation of Alaska’s current spending trajectory.

In short, both sides are missing the point about Alaska’s current financial situation. The problem confronting Alaska is not about revenue—while neither side will admit it, the most likely outcome is that both ACES and SB21 ultimately land Alaska in nearly the same place on revenue.

Alaska’s problem, instead, simply is that state government is spending too much regardless of which tax structure prevails. Ironically, for a state government that prides itself on being “conservative,” it is spending Alaska into the poorhouse at a rate that would make even California blush.

ACES Leads to Its Own Fiscal Cliff
Those who assert that retaining ACES, or something similar, will enable Alaska to avoid significant state spending cuts are wrong

Prior to the start of this year’s legislative session, the University of Alaska—Anchorage’s Institute for Social and Economic Research (ISER), the best economic think tank in the state, published another in an ongoing series of looks at state government fiscal policy. The study was based largely on the Department of Revenue’s Fall 2013 Revenue Forecast. That forecast assumed a continuation of ACES.
The ISER study provides a devastating look into where Alaska is headed if it continues down that path

According to the study—which, again, assumed the continuation of ACES—“[r]ight now, the state is on a path it can’t sustain. Growing spending and falling revenues are creating a widening fiscal gap. In its 10-year fiscal plan, the state Office of Management and Budget (OMB) projects that spending the [state’s current] cash reserves might fill this gap until 2023 …. But what happens after 2023

Reasonable assumptions about potential new revenue sources suggest we do not have enough cash in reserves to avoid a severe fiscal crunch soon after 2023, and with that fiscal crisis will come an economic crash.

Nothing that the proponents of the SB21 referendum have said subsequently undermines that analysis

At current spending levels, ACES leads inevitably to the same “fiscal crisis [and] economic crash” that the proponents argue that SB21 will cause.

The Governor’s Proposed Solution Isn’t Much Better
Because ACES produces a crash, the defenders of SB21 argue that it must be better. But the testimony submitted to the Legislature by the Administration’s own experts proves that wrong as well

In the closing days of the debate, legislators asked the administration to provide forecasts of the revenue streams anticipated to result from SB21 and ACES. The purpose of the requested analysis was to provide legislators with the ability to compare the impact on state budgets of continuing down the current path versus a future determined by SB21

The result ultimately was a series of PowerPoint presentations that compare the results of the two main approaches under various scenarios. Building on the assumption, which I believe is valid, that production will be higher under SB21 than ACES, the presentations concluded that the net present value of state revenues also would be higher under SB21

Importantly, however, the analyses also showed that, under the most likely scenarios, SB21 was not higher by much and certainly not enough to justify continued state spending at current levels

For example, at long-term price levels which are the equivalent of today’s $100/barrel, the analyses show that ACES is likely to produce an average annual revenue stream over the next thirty years of $3.3 billion at a 6 percent decline curve, and $4.3 billion at a 3 percent decline curve. SB21, on the other hand, is predicted to produce average annual revenues of $4.7 billion at a 1 percent decline curve, and $5.3 billion at a 0 percent decline curve—in other words, at a level where new production continually replaces normal field declines throughout the next thirty years

Under those assumptions SB21 produces more revenue than ACES, but not nearly enough to support the governor’s recently proposed spending levels.

Toward the end of the session, Governor Parnell announced a “five year” spending plan of $6.8 billion annually, with loopholes which permit even higher spending for “state-wide legacy projects.” Even using the best revenue estimate made by the administration’s own experts, at $100/barrel SB21 produces a long-term average annual revenue stream that is $1.5 billion below the governor’s proposed spending level

The deficit shrinks at higher oil prices. At a long-term price level which is the equivalent of today’s $110/barrel, for example, the administration’s experts predict average annual revenues produced by SB21 of $5.4 billion at a 1 percent decline curve, and $6.1 billion at a 0 percent decline curve. Better, certainly, but still significantly below the governor’s proposed spending level

According to the administration’s own experts, revenues adequately cover the governor’s proposed spending level only once long-term price levels exceed the equivalent of today’s $120/barrel, and even then only with the assumption of a long-term decline curve of 0 percent and without any revenue remaining to cover “state-wide legacy projects.” In order to deal with those additional factors, long-term price levels need to approach the equivalent of today’s $140/barrel, a level far in excess of current predictions.

What Is the Solution?
If both ACES and SB21 ultimately lead to the same end result, what, then, is the solution? The answer is remarkably simple: reduce government spending to levels which avoid the crash.

In the same ISER analysis in which it outlined the problem, ISER also offered an answer. “What can the state do to avoid a major fiscal and economic crisis? The answer is to save more and restrict the rate of spending growth. All revenues above the sustainable spending level of $5.5 billion—including Permanent Fund income, except the share that funds the dividend—would be channeled into savings.

Put more succinctly, based on current long-term forecasts—which don’t vary substantially between ACES and SB21—“Alaska’s state government can afford to spend about $5.5 billion” annually.

Ironically, while that level seems low when compared against recent annual spending levels of $7.9 billion for the just completed Fiscal Year 2013, and $6.8 billion authorized for Fiscal Year 2014 and proposed by Governor Parnell to be continued over the next five years, ISER’s number is in line with the spending levels achieved before the recent surge.

Setting aside supplemental appropriations, from Fiscal Years 2008 through 2011 Alaska government spent the following approximate amounts: $4.25 billion (FY 2008), $5.0 billion (FY 2009), $4.23 billion (FY 2010) and $5.1 billion (FY 2011). Other than the rising expectations of citizens increasingly trained to expect significant expenditures to be covered by government, nothing has changed between the periods justifying the rate of increase.

The governor and Legislature appear simply to have chosen to spend more because there was more available to spend and constituents, who do not have to pay for expenditures through increased taxes on their own incomes, have asked for more free (to them) goods. Rather than say no, and increase the state’s nest egg for future generations, the governor and Legislature have chosen to say yes.

The consequences of that policy are becoming clear—as ISER predicts, “fiscal crisis” and “economic collapse”—and claims by proponents that either ACES or SB21 will fix that are wrong. Only continued, significant spending reductions will suffice.

Bradford G. Keithley is the President and a Principal with Keithley Consulting, LLC, an Alaska-based and focused oil and gas consultancy founded by him. Keithley also publishes the blog, “Thoughts on Alaska Oil & Gas” at bgkeithley.com.

This article first appeared in the July 2013 print edition of Alaska Business Monthly magazine.

 

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