5. The Fiscal Gap
5.4 A Generic Fiscal Plan for Alaska
GENERIC FISCAL PLAN [ 2002 VERSION 1 ]
The absence of a plan for dealing with the fiscal gap is negatively impacting the economy and the state's ability to finance activities through borrowing.This Generic Plan demonstrates both the nature of the state's fiscal problem and how it can be solved.
The fiscal gap—the difference between annual general fund expenditures and revenues—is currently about $1 billion. It will continue to increase as inflation and population growth drive up the cost of delivering public services and as oil production, the primary source of state revenues, continues to decline. By the end of this decade the difference between a maintenance budget (growing with inflation and population) and revenues from current sources could reach $2 billion.
Any solution to the fiscal gap problem must include the two most powerful tools in the arsenal—broad-based taxes and use of Permanent Fund earnings. These must be augmented by budget restraint, excise, and other less powerful taxes as well as judicious use of the Constitutional Budget Reserve.
Many versions of a plan could be crafted based on use of these tools. This Generic Plan could be put into place through legislation and other actions in a multitude of ways.
Our inability to forecast future oil prices, investment returns, economic development, public sector demands, inflation, and other factors that define the size of the fiscal gap requires that our fiscal plan remain as flexible as possible.
Any solution to the fiscal gap problem must spread the burden of paying the costs of government fairly among all Alaskans, and no group should be singled out or asked to go first. To this end the Generic Plan calls for simultaneous imposition of a broad-based tax (income tax), reduction of the Permanent Fund dividend, and budget cuts from the maintenance level.
Any method of solving the fiscal gap will take jobs out of the economy. Staging over several years the introduction of new revenue-producing measures and budget reductions (including the Permanent Fund dividend) will minimize the "drag" on the economy from closing the fiscal gap.
Implementation of a fiscal plan today maximizes future flexibility in the use of our fiscal tools. Delay reduces our options.
B. CRITERIA FOR A FISCAL PLAN
FAIR— spread the burden fairly and equitably among Alaskans and across industries
SUSTAINABLE — preserve financial assets and endowment funds (AHFC, etc.)
REALISTIC — close the gap with real measures based on real assumptions
INCREMENTAL — phase measures in gradually over several years
COMPLETE — show the complete plan and timetable
STRATEGIC — minimize short-term economic impact and long-term disincentives to development
FLEXIBLE — maximize capability to adjust to changing circumstances
EFFICIENT —minimize administrative cost
STABLE — maximize revenue predictability
TRANSPARENT--keep it simple, logical, and politically possible
C. GENERIC PLAN FEATURES
1. CONVERT PERMANENT FUND TO ENDOWMENT
2. USE ENDOWMENT EARNINGS TO FUND GOVERNMENT AND DIVIDEND
3. INTRODUCE BROAD-BASED TAXES [ PERSONAL INCOME TAX] INCREMENTALLY
4. STEP DOWN DIVIDEND IN PARALLEL WITH GROWTH OF PERSONAL INCOME TAX REVENUES
5. IMPOSE SPENDING DISCIPLINE IN PARALLEL WITH DIVIDEND REDUCTION
6. INTRODUCE EXCISE TAXES INCREMENTALLY
7. REDUCE ROYALTY CONTRIBUTION RATE TO PERMANENT FUND TO 25%
8. CONVERT CONSTITUTIONAL BUDGET RESERVE TO OIL REVENUE "CUSHION"
9. RETAIN EMERGENCY FUND IN EARNINGS RESERVE AS FINANCIAL EARNINGS "CUSHION"
D. THE TARGET
When all its features are in place, the Generic Plan solves the fiscal gap problem through a combination of use of Permanent Fund earnings, revenues from broad-based taxes, and revenues from other new sources. The legislature retains the authority to determine the levels of both traditional government expenditures and the dividend as well as how they will be financed—how permanent fund earnings will be allocated and the mix of taxes and tax rates.
The Generic Plan closes the fiscal gap, spreads the burden fairly across Alaskans, retains maximum flexibility, and minimizes damage to the economy.
E. SENSITIVITY TO CHANGING CONDITIONS
HIGHER INFLATION — With a cap on spending, higher inflation puts a tighter squeeze on real expenditure growth, and since the Permanent Fund is protected from inflation, the fiscal gap is smaller.
HIGHER OIL REVENUES — Higher oil revenues would allow revenues to remain in the CBR and Earnings Reserve and this, in turn, would permit tax rates to be lower, dividends to be higher, and expenditures to be higher.
LOWER OIL REVENUES — The cushion in the Earnings Reserve would be used in the event of lower-than-anticipated revenues.
LOWER PERMANENT FUND EARNINGS — The cushion in the Earnings Reserve would be used in the event of lower-than-anticipated fund earnings.
HIGHER GENERAL FUND SPENDING — In the short term this would increase the draw from the CBR and Earnings Reserve. In the long run it would reduce the Permanent Fund dividend.
F. GRAPHICS [illustrating methods to describe and evaluate a fiscal plan]
GENERAL FUND BASICS — The general fund maintenance budget grows with inflation and population. General fund revenues from current sources, dominated by oil, will continue to fall.
GENERAL FUND REVENUES FROM CURRENT SOURCES — General fund revenues from oil will continue to fall. Non-oil revenues are not growing.
THE SIZE OF THE DEFICIT — The deficit is the difference between the general fund maintenance budget and general fund revenues from current sources. The deficit is increasing over time. Its exact size depends upon the size of the budget and revenues which fluctuate with the price of oil.
BUDGET BALANCING MEASURES — Initially, the measures to close the fiscal gap are dominated by use of the CBR, but after the transition period the earnings of the Permanent Fund, broad-based taxes, other revenue measures, and budget restraint all play a role.
REAL PER CAPITA SPENDING — Both general fund spending and the dividend fall in real dollars.
FINANCIAL ASSETS AT YEAR END — The real value of state financial assets is sustained.
NET IMPACT ON HOUSEHOLDS — Households of 3 at different income levels ($20 to $100 thousand) receive more from state government (dividend) than they pay in income tax in 2002. In 2010 that would also be true, given the assumptions of this Generic Plan.
JOB GROWTH COMPARED TO "DO NOTHING" — The "do nothing" scenario is to spend down the CBR and then cut the budget.
STATE DEPENDENT JOBS RELATIVE TO 2002 — The drag on the economy from the closure of the fiscal gap.
PERMANENT FUND EARNINGS — The nominal and real fund earnings as well as their disposition after the endowment rule becomes effective.
GENERIC FISCAL PLAN [2002 VERSION 1]
The Generic Plan would be fully in place for the FY 2007 budget.
The SPREADSHEET and TIMETABLE describe one possible way to implement the Generic Plan, largely based upon proposed legislation. It is similar, in its main features, to many of the ideas put forward by the Fiscal Policy Caucus.
A. THE SIZE OF THE BUDGET
A temporary spending cap that sunsets with the FY 2007 budget is one way to impose budget discipline during the transition. After that time budget discipline would come from the annual determination, made by the legislature and administration, of the share of Permanent Fund earnings used to fund the budget vs pay the dividend.
B. BALANCING THE BUDGET
The final balancing of the budget would draw upon the CBR through FY 2004, the Earnings Reserve in FY 2005 and FY 2006, and a share of Permanent Fund earnings in following years.
C. THE CBR
The CBR continues to fill the fiscal gap through the FY 2004 budget, when about $1 billion would remain. After that the CBR becomes a "cushion" to smooth out fluctuations in oil revenues around their downward TREND—the original idea for the CBR. (The CBR earnings are a continuing revenue source.)
D. BROAD-BASED TAXES
A progressive personal income tax (the rate increasing with income) would be established with collections beginning in CY 2003. The rates would start low and gradually increase over 5 years, reaching their target rates in CY 2007 at which time the tax would generate about $450 million.
E. THE DIVIDEND
The existing dividend formula would remain in place through the FY 2006 dividend payment (made in the fall of 2006), except that it would include a deduction equal to the projected personal income tax revenues for the year. Starting in FY 2007 the legislature would determine the size of the dividend as the share of Permanent Fund earnings not used to fund regular state programs.
F. MISCELLANEOUS REVENUES
Other taxes and revenue-generating measures that might be implemented include reduction of the contribution rate to the Permanent Fund down to the constitutionally mandated 25%, increase in the alcohol or fuel tax, and imposition of a cruise ship or employment tax.
G. THE EARNINGS OF THE PERMANENT FUND
Permanent Fund earnings are deposited into the Earnings Reserve based on the existing methodology until FY 2007 when the endowment rule goes into effect. Starting in that year 5% of the moving average of the market value of the Fund is transferred directly into the General Fund.
H. THE EARNINGS RESERVE
Permanent Fund inflation proofing is deferred for the FY 2003 through FY 2005 budgets with the cash remaining in the Earnings Reserve. This reserve cushion ensures our ability to fund government and the dividend during the transition in the event of a series of years of poor Permanent Fund earnings. In FY 2006 the deferred inflation proofing is repaid and the balance of the Earnings Reserve becomes an emergency fund.
Page Updated December 2, 2002
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