Gov. Mike Dunleavy is proposing structural changes to the Permanent Fund Dividend that could have major effects on annual dividend as well as the state budget going forward.
Dunleavy said he will also take the change to the voters and abide by the results, up or down.
It could be a tough sell for the governor.
The changes were spelled out when Dunleavy introduced his Fiscal 2022 budget proposal in mid-December but they would take effect the following year, in FY 2023 and beyond, state administration officials have said in briefings to community groups.
The governor’s proposal is to change a state statute that spells out how the PFD is calculated. Instead of calculating the dividend based on half of the Fund’s realized, or cash, earnings per year averaged over the previous five years, and with the money paid from the Permanent Fund’s earnings, the governor’s proposal is to make it part of the state’s current Percent-of-Market Value, or POMV, draw for the state budget, also paid from Fund earnings.
The annual POMV is 5 percent of the Fund’s total value. It functions in a fashion similar to that of large endowments that provide income for universities or charitable foundations.
The difference between the current PFD statute and the POMV is that total market value in the latter includes gains of value in investments like stocks that are held unsold in the investment portfolio of the Fund.
The current PFD payment statute, in contrast, allows payments for the dividend only from realized gains, or cash income, that accrue when stocks are sold and also when interest is paid on bonds or rental payments are received from the Fund’s real estate holdings.
Fund managers have argued that calculating the dividend on realized earnings can lead to short-term distortions, for example when the sale of a large asset like a real estate holding results in a large one-time gain that pumps up realized earnings for the year in which it occurs.
It can also, in theory, lead to situations, such as an unexpected market downturn, where cash income might not appear in the amounts expected and there would be a shortfall in money available for the PFD payment.
If that were to happen, the Fund’s managers might have to sell stocks or other assets to pay the dividend, which financial advisors have said is an unsound practice. Asset sales should be timed to the best market conditions and not short-term cash needs unless there is an unusual need like an emergency, financial advisors say.
The best practice is to make the payout as part of the overall Fund value that includes the unrealized gains. This smooths out the process and makes it more predictable.
While the two approaches are similar is that they both take 50 percent of Fund income averaged over five years, one from realized income and the other a payment based on total market value, the governor also proposes that the PFD be paid from within the amount the state receives from the POMV, rather than paid separately.
Here’s why this is important:
Under the current POMV, at 5 percent, about $3.1 billion will be available next year to support the budget. This helps offset the effects of diminished oil and gas resevenues, which have plummeted since 2016.
If 50 percent of this is reserved for the PFD, or about $1.5 billion a year, the effect is to reduce funding for the budget by 50 percent, or about $1.5 billion.
The effect of this would be to create ongoing deficits after next year in the range of a billion dollars a year, according to long-range projections by the state Office of Management and Budget.
Projected revenue to support the budget would drop from $4.17 billion for FY 2022, the state financial year beginning July 1, to $3.029 billion in FY 2023; $3.193 billion in FY 2024; $3.26 billion in FY 2025 and $3.27 billion in FY 2026.
Assuming state general fund appropriations remain in the $4.1 billion to $4.21 billion range ver those years annual deficits from $950 million to $1.2 billion would occur. The estimates by OMB are from a presentation Neil Steininger, director of the office, made to Commonwealth North, an Anchorage business policy group, on Dec. 17.
Steininger said the administration has no current proposals to fill the gap, which is created by inserting the dividend into the annual POMV payment to the state.
There are ways of covering the deficit, of course. One is to increase the annual POMV draw from the Permanent Fund above 5 percent, but that is a course financial advisors say could endanger the long-term sustainability of the Fund.
Another option is to reduce the state budget by the amount of the deficit, which in effect would achieve the large cut the governor proposed in his first year in office, which was rebuffed by the Legislature. A third option is not to pay the PFD.
The reason why this could be a tough sell in an election, if the governor take the change in PFD to voters, is that the PFD and POMV calculation methods are complicated and difficult to explain to the public. When presented with a ballot proposition they don’t fully understand voters typically say no.
This happened two decades ago when former Gov. Tony Knowles took a Permanent Fund change, in fact the adoption of a POMV, to voters in a special election. The proposal was heavily defeated, which resulted in political leaders becoming so gunshy of public reaction that it was almost 20 years before the current POMV was adopted, this time by the Legislature without a public vote.