How Did Alaska Get to this Place, and What Are the Options Now?

Fiscal update by Cliff Groh, ACG Board Member, September 30, 2019

After an exhausting and apparently endless seven-month fight
over budget cuts and the size of the Permanent Fund Dividend, the State of
Alaska is set up for continuing struggles over the same issues in the coming
years. You might be tired of it all, but this set of fiscal conflicts is primed
to keep going.

Alaska politics is tumultuous (Mike Dunleavy is the sixth person to be elected Governor in the last six elections, as Governing magazine has noted). Alaska politics is also unusual (try explaining it to people outside the state). One reason for the tumult and the uniqueness is existential. The issues of what the State of Alaska should do and how to pay for what it does raise questions like “What kind of Alaska can we have?” and “What kind of Alaska do we want?”

Let’s set the stage with familiar yet critical facts. Alaska
oil production has fallen by more than 75 percent in the last three decades,
going from over 2 million barrels per day in the late 1980s to less than
500,000 a day now. Meanwhile, oil prices have not stayed high enough to
compensate for the fact that the State of Alaska now has so much less oil from
which to collect royalties and taxes. World oil prices, in fact, bounce around
a lot and in 2019 have been substantially below what they were in the summer of
2014 (even though the Middle East is roiled by war).

The combination of the big decline in Alaska oil production
and unpredictable world oil prices well under historical highs creates a big
problem for our state. From the early 1980s to 2018, the State of Alaska’s
fiscal system was based on having a whole bunch of new oil money coming in, and
that system stopped working about five years ago.

The fiscal system changed in 2018 with the adoption of
legislation—Senate Bill 26—that provides for the use of substantial amounts of
Permanent Fund earnings to pay for conventional public services. Even with that
injection of Permanent Fund earnings into the regular budget, however, the
massive drop in oil revenues in the absence of unrealistically high stock
market returns or an apparently unsustainable long-term run-up in oil prices
means that the State of Alaska still lacks sufficient revenues to pay for the
level of public services a majority of Alaskans seem to want—including a
Permanent Fund Dividend paid pursuant to the formula set out in Alaska
statutes—without instituting a broad-based tax and/or raising oil taxes. That
last sentence runs 86 words, but that’s what it takes to sum up our fiscal
circumstances. (The State of Alaska could always finance itself for a while by
going through all its spendable savings, but that is of course a short-term
strategy at best.)

It All
Seems So Different Now from Last Fall

You have probably observed how this account of Alaska’s
current fiscal situation is at odds with how the Governor’s race went last
year. Former State Sen. Mike Dunleavy ran and won on a platform of super-sized
Permanent Fund Dividends (remember the Dunleavy Dividend of $6,700 promised to
arrive in October of 2019?); no personal taxes; and relatively small and
painless budget cuts.

The Dunleavy campaign’s platform regarding the budget is
crucial and poorly remembered. Independent journalist Dermot Cole and Alaska
Public Media’s Nathaniel Herz have labored to set out what candidate Mike
Dunleavy actually said on the trail in 2018. Candidate Mike Dunleavy promised
to increase spending on K-12 education and not cut funding for the University
of Alaska, Power Cost Equalization (PCE), and the Pioneer Homes—among other
agencies. He also specifically promised not to “lop off and chop off big
aspects” of the ferry system (officially called the “Alaska Marine Highway
System”) and said that there was “no plan to hack, cut, or destroy” that ferry
system.

Instead of making cuts to these popular programs, candidate
Dunleavy said in 2018 that he would save $200 million by cutting 2,000 funded
but unfilled positions, save another $100 million with a voluntary school
district health insurance consolidation plan, and save another $150 million by
making Medicaid more efficient. Dunleavy told the Fairbanks Daily News-Miner in
August of 2018 that “I do not have a specific program I would like to reduce or
eliminate.” When he did identify specific budget cuts he wanted to make,
candidate Dunleavy said that he would axe a $4.5 million study of fast rail
between Palmer and Anchorage and not fund “climatologists.”

Following
the Election, Gov. Dunleavy Dramatically Changes His Positions on the Budget
and the Dividend

Mike Dunleavy was elected Governor on November 6, 2018,
receiving 51 percent of the vote. The next month, the new Governor’s budget
only included funding for a $3,000 Dividend in 2019, while the administration
said that additional funding to pay a larger 2019 Dividend would come in
legislation outside the budget. By January of 2019, the administration had
abandoned the plan to send a Dividend of $6,700 to all Alaskans in October of
2019. Instead, Gov. Dunleavy proposed to pay bigger Dividends in future years
to compensate Alaskans for the amounts the Legislature and former Gov. Bill
Walker had cut Dividends in 2016, 2017, and 2018 compared to what the payments
would have been under the formula for Dividends adopted in the 1980s that is
still on the books. Eventually, Gov. Dunleavy’s demand for the 2019 Dividend
turned out to be that $3,000 that would be paid pursuant to that formula
adopted in the 1980s.

The Dunleavy switch on the funding for conventional public services came in February of 2019, and it was big.

The Governor proposed on Feb. 13 the following budget
reductions compared to the previous year (the figures in this paragraph
represent cuts in Unrestricted General Funds according to the Alaska
Legislative Finance Division):

  • K-12 education—25 percent cut
  • Medicaid—38 percent cut
  • University of Alaska—41 percent cut
  • Department of Transportation and Public
    Facilities (DOTPF)—32 percent cut

The Governor also proposed to:

  • Shift $420 million in petroleum property tax
    revenues from local governments to the State of Alaska
  • Eliminate the endowment for Power Cost
    Equalization (PCE)
  • Substantially increase the fees charged to
    Pioneer Home residents
  • Zero out funding for public radio and TV
  • Cut funding for the ferry system (which is part
    of DOTPF) by at least 65 percent—requiring that the ferries at least be tied up
    for the winter—while exploring privatization

Along with claiming that the public knew that he would
propose big budget cuts when he was elected, the Governor’s defense of his
switch on the budget cuts was that oil prices were lower in December of 2018
than they were briefly in October of 2018.

Note that despite various statements and suggestions to the
contrary, Gov. Dunleavy did not propose in February of 2019 a budget that
aligns expenditures with current revenues. The Alaska Legislative Finance
Division broke out the Governor’s budget proposal as $650 million in reductions
in agency operations, $520 million in cost-shifting from the State government
(primarily or entirely to local governments), and $352 million in use of
reserves.

The
Public Protests and the Legislature Reacts

Gov. Dunleavy’s proposed budget cuts galvanized public
opposition. Testimony at legislative hearings ran overwhelmingly against the
proposed cuts, both generally and in their specifics. Letters, e-mail messages,
and telephone calls to legislators’ offices also apparently leaned against the
proposed cuts.

Polling results regarding the Governor’s budget proposal, however, showed that Alaskans were more evenly divided than the public testimony suggested. A poll conducted in late March and early April of 2019 showed that 28 percent strongly supported Gov. Dunleavy’s budget proposal and 21 percent mildly supported it while 32 percent strongly opposed it and 14 percent mildly opposed it. Another public opinion survey taken in late May and early June of 2019 provided similar numbers. That poll showed that 25 percent strongly supported the Governor’s budget proposal and 22 percent somewhat supported it, while 37 percent strongly opposed it and 10 percent somewhat opposed it.

The Legislature rejected most of Gov. Dunleavy’s proposed
budget cuts and re-allocations. The operating budget the Legislature passed in
June at the end of the first special session was $190 million lower than from
the previous year, with most of the cuts coming from Medicaid ($87 million) and
the ferry system ($40 million). (Once again, these figures represent
Unrestricted General Fund (UGF) spending as reported by the non-partisan Alaska
Legislative Finance Division.) In an under-reported move, the Legislature also
voted to make a special transfer of $9.4 billion from the Permanent Fund
Earnings Reserve to the Permanent Fund principal—which under the Alaska
Constitution cannot be spent without a vote of the people—with the announced
intent of satisfying inflation-proofing over the next eight fiscal years.

The Legislature was unable to pass a capital budget and
could not decide on the level of the Permanent Fund Dividend before the end of
the first special session came in mid-June.

The
Governor Brings the Veto Pen the First Time, and the Legislature Adds Back Most
of the Vetoed Funding in a Second Special Session

Governor Dunleavy responded on June 28 by vetoing more than
$400 million from the budget, adopting much of the approach he had unveiled in
the budget cuts he had proposed in February (which—as noted earlier—was
contrary to the specific statements he made during his gubernatorial campaign).
Prominent among the vetoes announced were $130 million from the University of
Alaska (a cut in line with the Governor’s budget proposal in February) and $77
million from Medicaid (on top of the Legislature’s cut). Among the rest of the
182 line-item vetoes were $49 million for school debt bond reimbursement and
Senior Benefit payments totaling $21 million, resulting in a planned
elimination of the latter program. (These figures were those announced by the
Dunleavy administration’s Office of Budget and Management.)

The Governor also vetoed $5.4 billion of that special
appropriation from the Permanent Fund Earnings Reserve to the Permanent Fund’s
principal.

The Legislature’s initial responses to these vetoes were hampered by both a temporary factor and a structural issue. The short-run factor was the Governor called the second special session to be held at Wasilla Middle School, while most legislators gathered more than 500 miles away in the State Capitol in Juneau. The structural issue was that Alaska’s Constitution was intentionally designed to make the Governor one of the nation’s most powerful. A constitutional provision that it takes a ¾ vote of the Legislature to override a veto of an appropriation is a critical element of what makes Alaska’s Governor so powerful. This requirement to line up 45 votes (as opposed to 31 or 40) out of the 60 members of the Legislature in order to override a line-item veto of an appropriation is a giant weapon for the Governor who can make that veto. (Alaska is the only state with a requirement as high as ¾ of legislators to override a governor’s veto of an appropriation, according to the National Conference of State Legislatures.)

Hampered by both impediments, the Legislature failed to
override the budget vetoes. When all the legislators eventually gathered in
Juneau later in July, the Legislature instead passed a new bill that restored
all but about $20 million of the more than $400 million in operating budget
vetoes that the Governor vetoed June 28. (The conflict over funding for K-12
education was put off, as the Legislature and the Governor agreed to put the
issue on hold while the issue of constitutionality for forward funding for
education was resolved in the courts.) The Legislature also approved a capital
budget at the end of July, resolving a complicated funding question called the
“reverse sweep.”

The debate over the Dividend ate up much of the second
special session in July, much as it consumed the Legislature all year. The
Legislature passed a bill providing for a $1,600 Dividend rather than the
$3,000 Dividend based on the formula adopted in the 1980s that the Governor had
sought for months. The votes on the new budget bill—including the different
Dividend figure—were aided by the fact that Gov. Dunleavy’s approach helped
unite in opposition to him a number of Republicans and Democrats who before his
election were not allies.

The Legislature then adjourned in early August and awaited
the Governor’s next move.

The Rise
of the Recall and the Return of Ben Stevens to Power Seem to Change the
Governor’s Mindset on How Much to Cut How Fast

Two other events occurred at the end of July that may have
been related but definitely affected the Governor’s relationship with the
Legislature. A recall effort was announced against the Governor with two
Republicans—one a coal baron—and a Democrat as the three co-chairs. Two of the
five specific allegations in the recall specifically related to the Governor’s
budget vetoes, and signatures came much faster than expected (organizers
submitted just over 49,000 signatures collected in just over a month).

The other notable announcement on July 31 was the
replacement of Tuckerman Babcock as Chief of Staff with former State Senate
President Ben Stevens. Some observers saw Babcock as an ideologue who may have
overestimated the appeal of a $3,000 Dividend in his advice to the Governor,
while the experience of Stevens in the legislative leadership may temper his
counsel. Legislators reported that Gov. Dunleavy moderated in his negotiations
following the naming of Stevens as Chief of Staff. (Given that in 2007 the U.S.
Department of Justice got two men to plead guilty to bribing Ben Stevens (even
though he was never charged—much less convicted—of any crime), some observers
are surprised that he has been put in charge of a public official’s image
rehabilitation.)

Another step in changing the Governor’s image came in the
announcement Sept. 16 that Donna Arduin was out as the Governor’s Director of
Office of Management and Budget. Arduin had been a lightning rod for criticism
of the administration’s budget-cutting approach, and insiders expect that the
threat of recall will lead Ben Stevens to continue to work hard to make Gov.
Dunleavy appear more empathetic.

While the Governor was pondering a second round of vetoes in
August, he announced an agreement apparently aimed at lowering the temperature
on University funding, the target of his biggest operating budget veto in
dollar terms. Gov. Dunleavy signed on August 13 a document approved by the
University of Alaska’s Regents in which the Governor stated his intent to
replace a $135 million budget cut in one year for the University with a $25
million cut in State of Alaska funding for the current fiscal year and another
$45 million cut over the following two years. Skeptics noted that the
Legislature—not the University of Alaska’s Regents—retains the constitutional
power to make appropriations for the University (subject of course to the
Governor’s veto and the Legislature’s power to override such a veto).

The Governor announced on August 19 his vetoes on the budget
bill passed in July. The action attracting the most attention was his decision
to not veto as insufficient the appropriation that would produce a Permanent
Fund Dividend in 2019 of about $1,600. Gov. Dunleavy vowed to fight for a
second check of $1,400 to bring the total Dividend payments to $3,000 for this
year. To get that total of $3,000, he said in a video announcement that he
expected to call a third special legislative session this fall to seek an
additional appropriation from the Permanent Fund Earnings Reserve to pay for
the second check this year.

That same day as the announcement of the non-veto of
Dividend funding that generated the $1,600 payment, Gov. Dunleavy unveiled the
vetoes on the bill the Legislature passed in July adding back funding after his
first round of vetoes. Highlighting the vetoes in Round 2 were $48 million from
Medicaid services (including funding for adult preventative dental Medicaid
services in an intended elimination of the program); $49 million from school
bond debt reimbursement; and $2.7 million for public radio and TV. The Governor
vetoed $5 million the Legislature added back in funding for the Alaska Marine
System; with the Legislature having cut $43 million in funding during the 2019
session, some coastal communities off the road system such as Cordova will go
as much as seven months this winter without ferry service.

Simultaneously, the Governor let stand some of the add-backs
made by the Legislature in July. Prominent in the restorations (that is, the
July appropriations not vetoed) were $21 million for the Senior Benefits
program and $3.9 million for the Alaska State Council on the Arts.

Where Do
the Numbers Stand Now?

Following the vetoes announced in mid-August on the add-back
bill (House Bill 2001), the Alaska Legislative Finance Division reported that
the budget without Dividends was $4.3 billion in Unrestricted General Funds,
which is $486 million lower than last year—a 10 percent reduction. Add in the
approximately $1.14 billion to pay for a Permanent Fund Dividend of $1,606 this
year, and you get to $5.4 billion and a roughly balanced budget for Fiscal Year
2020, the year that runs July 1, 2019-June 30, 2020. Add in another $1,400 to
pay for a second Dividend check this year—and absent new revenues—the State of
Alaska would be in a deficit of close to $1 billion this year.

What’s
Coming Up? (Hint: More Proposed Big Budget Cuts from the Governor)

As noted above, Gov. Dunleavy has stated that he expects to
call for this fall a special session—the third special session this year—to
focus solely on paying the second check of $1,400 to make the $3,000 total
Dividend this year that he has promised. Some legislators have said that this
third special session should also address another appropriation bill that would
reverse some of the vetoes made in the second round. Another potential topic at
that potential special session this fall is a new formula for distribution of
Permanent Fund Dividends that would be sustainable in light of the new
realities the State of Alaska confronts. Some lawmakers kick around the idea of
a grand bargain that would resolve these questions simultaneously.

Whatever happens this fall, Alaskans need to know that Gov.
Dunleavy is by all indications committed to additional funding cuts in his
budget proposal for the next fiscal year which by law must be unveiled no later
than December 15. When a legislator pointed out at a public gathering this
summer that Gov. Dunleavy had never proposed a budget that in fact aligned
expenditures with current revenues, Commissioner of Revenue Bruce Tangeman
responded that he was confident that the Governor would do so in that proposal
to be submitted for the upcoming fiscal year. This statement strongly implies
that the Governor’s next round of proposed budget cuts will total $500 million
or more.

K-12 education is the most likely big target for that next
blitz of the Governor’s proposed budget cuts. Recall that the Governor proposed
a 25 percent budget cut—approximately $300 million—to K-12 funding back in
February, and that fight only got sidetracked this year because of the
Governor’s agreement with the Legislature to put the issue on hold while the
courts resolved the question of the constitutionality of forward-funding.

Math and history both dictate that the Governor—who spent
nearly two decades as a teacher, principal, and school district superintendent
in the Bush—reach for the hatchet on K-12 education. Gov. Dunleavy has said
repeatedly that he is determined to align expenditures with current revenues,
and K-12 education is the biggest non-Dividend spending item in the budget.
(And with the Dividend still legally at $1,606, K-12 is the largest
expenditure; it’s the $3,000 Dividend that would make that outlay the biggest
of all expenditures.)

In addition to another wave of budget cuts that will be
fought over in the legislative session starting in January, the Governor seems
likely to continue to push for his three proposed constitutional amendments,
each of which would have a major impact on Alaska’s fiscal system. One
amendment would substantially tighten the existing spending limit. A second
would require all new taxes or tax increases to be approved by both the
Legislature and a vote of the people. The third would guarantee in the Alaska
Constitution the annual payment of Permanent Fund Dividends pursuant to the
distribution formula that has been on the statute books since the 1980s.

What Are
the Constraints on What Can Happen?

In the short run, fear of the recall might slow down some of Gov. Dunleavy’s efforts to cut the budget and reshape the fiscal system. Regardless of what happens with the recall, Alaskans need to
ponder some hard facts about saviors, desires, and goals.

Let’s start with saviors. Alaskans have long imagined or
speculated that various rescuers are coming over the hill to save our state from
making difficult fiscal choices. Those potential saviors have been at various
times ANWR; the gasline/LNG/various other efforts to commercialize/monetize
natural gas on Alaska’s North Slope; offshore oil development; the Pebble Mine;
taxation of non-residents only; and small and relatively budget cuts.
Unfortunately, these rescuers have not arrived, and they seem unlikely ever to
get here due to a number of factors, including economic and technological
changes and (in the case of taxing non-residents only) the U.S. and Alaska
Constitutions. Alaska is transforming, and the announced departures of BP from
Alaska and the flagship Nordstrom department store from downtown Anchorage both
represent aspects of that transformation. No outside force or magic trick is
going to save us, folks, and we must save ourselves.

In saving ourselves, we need to distinguish between desires
and options. Many Alaskans want the State of Alaska’s fiscal system to run as
much as possible as it did between the early 1980s and the mid-2010s. The four
pillars of those three and a half decades were:

  • Large amounts of new oil money generated by
    taxes and royalties regarding oil development
  • Relatively high state spending per capita
    compared to the national average
  • No use of Permanent Fund income/earnings in
    significant amounts beyond the payment of Permanent Fund Dividends or to
    protect the Permanent Fund’s principal from the effects of inflation (this
    latter effort is known as “inflation-proofing”)
  • No general statewide taxes on individuals or
    significant general statewide taxes on Alaska-based corporations

Three out of four of these pillars have fallen. Large
amounts of new oil money stopped arrived in the mid-2010s; the annual budget
has fallen substantially since the mid-2010s and after adjusting for inflation
and population is now below what is was before this fiscal system was created
in the early 1980s; and starting in 2018 the State of Alaska has come to rely
heavily on Permanent Fund earnings to finance the budget. Despite the falling
budget and use of a lot of Permanent Fund earnings/income to pay for
conventional public services, the State of Alaska still has a deficit—and will
continue to do so for any future seeable now—without either raising additional
revenues and/or not following the statutory Permanent Fund Dividend formula.
(To get an idea of revenue options discussed now, the income tax that the
Alaska House passed in 2017 would have generated about $700 million per year,
and supporters of the recently proposed oil tax initiative assert that it would
raise approximately $1 billion annually.)

On top of all that, the State of Alaska also faces pressures
to increase the budget that has recently been going down each year. One
pressure is an aging population, as people over 70 tend to need more medical
care and other services than people between, say, 20 and 40 years of age. A
second pressure is the capital budget; spending for infrastructure has fallen
substantially in the last four years, and most experts see it as too low now. A
third upward force on the budget is the State of Alaska’s officially adopted
plan to pay off the unfunded liabilities for the Public Employees’ Retirement
System (PERS) and the Teachers’ Retirement System (TRS). Regarding that last
factor, the State is paying off the unfunded liabilities on a 25-year plan that
ends in 2039; those payments are one of the half-dozen biggest spending items
in the budget, and they increase each year until the final payment in 2039.

Given current realities, Alaskans appear to want mutually
contradictory outcomes. A lot of Alaskans seem to want big budget cuts in
theory and in general, but rebel loudly when those cuts are made specific and
real and rule out the additional taxes and/or reduction of Permanent Fund
Dividends necessary to finance the actual budget they seem to want. Alaskans
need to figure out what desires are unrealistic and investigate the genuine
options for our state.

The choices among options should be guided by an explicit
discussion of goals. Once again: What kind of Alaska can we have? What kind of
Alaska do we want?

——————————

Cliff Groh speaks only for himself in this article.