What happens if we don’t inflation-proof the Permanent Fund?

The first chairman of the Alaska Permanent Fund Corporation said it isn’t a question of whether inflation will nibble away at your wealth, but by when and by how much.

That’s conventional wisdom, and those who grew up with the Permanent Fund have become accustomed to hearing how important it is to inflation proof Alaska’s biggie-sized piggy bank.

But today, inflation-proofing is not quite as important as in prior years because the fund, due to its more diverse mix of investments, inflation-proofs itself.

In fact, those who dwell on inflation-proofing are kind of seen as “old school.”

The proposals being offered to fix the State of Alaska’s spending problem rely on some kind of restructuring of the Permanent Fund, and eliminating inflation-proofing is an implicit part of the plans.

That’s OK in theory, but there are risks, experts say.

For example, if the fund invests $1 million into a stock and 10 years later it’s worth $10 million, the fund managers may want to sell it and realize gains. If they do, $9 million will go into the Earnings Reserve Account and $1 million — the original investment — would be retained by the Permanent Fund. That puts the original investment back into the fund, but by then, inflation will have eroded it.

On the other hand (as economists often say), if an investment loses money – as many do – then that loss subtracts from the gains in terms of overall deposit to the Earnings Reserve. In reality, there is discretion surrounding what the Fund states as total net “gains”.

The Earnings Reserve Account gets used in part to fund future state government, in part to pay Permanent Fund dividends, and some could get rolled back into the principal of the fund itself, if the Legislature chooses. In recent years, the Legislature has sent $16 billion in excess revenues into the Permanent Fund to build it up and guard it against inflation.

To fix the State’s fiscal crisis, Alaska may be going into a phase where the Permanent Fund just won’t grow for a time, as it has for many years. It may hit a flat spot while lawmakers try to figure out how to fund government.

Having said that, there is no way to know what financial markets will do. The fund may grow healthily, for all we know, regardless of what lawmakers do with the Earnings Reserve Account.

OPTION 1-DUNLEAVY BILL: The plan offered by Sen. Mike Dunleavy actually would allow the fund to grow, although slowly. Fifty percent of the utilized amount of the Earnings Reserve Account would pay Alaskans their dividends, and 50 percent would be used for state services. Utilized amount means 50 percent of a five-year moving average, so that it is not whipsawed by short-term movemetns in financial markets.

The Alaska Permanent Fund Corporation has provided data showing that the Permanent Fund transfer amount and the Earnings Reserve Account both grow over 10 years using Dunleavy’s approach.

What is also a part of Dunleavy’s plan is relatively large and growing dividends accompanied by deep cuts in spending. Examples of that could include closing schools,  eliminating Medicaid options, curtailing ferry service, and stopping automatic pay increases. All tough decisions.

All the while, the State would be mailing large and growing dividend checks to Alaskans, while spending at a deficit, even with the Permanent Fund support. Many Alaskans will find that to be a head scratcher.

Dunleavy’s plan has deep budget cuts — draconian, perhaps — and a spending cap.

OPTION 2-GOVERNOR’S BILL: Gov. Bill Walker’s budget bill, however, takes all of the earnings of the Permanent Fund. Under his scenario, the fund has no way to grow, at least in the immediate future. He also wants a motor fuel tax, which would raise a nominal amount of money. He is probably counting on the Legislature to give him some other kind of tax as well. The budget cuts offered by the governor are merely cosmetic.

The other aspect with the governor’s plan is he takes a big chunk of earnings to fund this year’s budget (FY17), as well as FY 18, in order to leave a bigger balance in the Constitutional Budget Reserve.

The governor’s approach is a complete flip of what he proposed last year, when he had all sources of available funds pouring into the Permanent Fund in order to have a higher balance that could generate $3 billion a year in revenue to pay for state government.

Now he’s offering the bill that the Senate actually passed last year, with royalty reduced to 25 percent, no inflation-proofing and a 5.25 percent of market value draw off the fund (based on average of five prior years).

Why Walker has changed his approach 180 degrees has yet to be explained.

Inflation-proofing has always been a big discussion point around Permanent Fund management. Is it even relevant given current Permanent Fund management techniques? We suspect not.

That will be debated in Juneau this session, and there are arguments to be made on both sides.

Readers who want to join the fray may wish to school up on the meaning of POMV. And while there will be a lot of heat over the discussion, readers may also want to pray for light.