HomeMy WebLinkAboutAPA798THINKING ABOUT ALASKA'S FINANCIAL FUTURE
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THINKING ABOUT ALASKA'S FINANCIAL FUTURE
Draft
prepared for the
House Finance Committee
Alaska State Legislature
by
Scott Goldsmith
Assistant Professor of Economics
Inst1 t ute of Socia l and Economic Research
University of Alaska
Anchorag e -Fairbanks -Juneau
January 14, 1980
• •
THINKING ABOUT ALASKA'S FINANCIAL FUTURE
I. The F iscal Conditions of the State • • • . • • • • • • • • • 1
II. Recycling Alaska's Petroleum Wealth.
III. Recycling Alaska 's Wealth lHth Employm ent
Growth as a Co nsidPration . . . • . • •
• • • • • • 20
• • • • • • 28
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I. THE FISCAL CONDITION OF THE STATE
A. Pe troleum Revenue s
The largest source of state revenues for the foreseeable future is
the petroleum industry. The Department of Revenue October 1979 forecast
of petroleum revenues from royalties and severance taxes estimates that
b etween 1980 and 1994 the s tate will be the recipient of about $47 bil-
lion from the se two sources.1 By way of contrast, at curre nt rates,
the larges t nonpetroleum revenue source--the pers onal income tax--might
gen era te $6 billion ove r the same period. The state government--and
loc al government which depends heavily on state assis tance--is clearly
dependent upon p e troleum revenues .
Depend e nce upon p etroleum revenues is not new for the state, but it
has increased drama t ically in the last two decades . The shif t in the
historic pattern of sources of state finances represented in Figure 1
reflects the dual facts that Alaska has always been dependent upon
p e troleum revenues and tha t economic growth in the state has closely
paralleled grmo~th of o il and gas revenues.
The concern with dependence upon a single source of revenue is that
it may be unstable and this instability may c a rry over into inability o f
governmen t to fund a stable and balanced program for needed goods and
services. Recent events S'lch as the temporary suspension of the Veterans '
l oans program have shown that revenue instability can be a real problem.
The flow of total petroleum revenues over the next 25 years might
ta~e the shape depicted in F igure 2, where the October 1979 Department
o f Revenue projections of roya lties and severance taxes have been ex-
t rapolat..ed forward and sepa rate estimates of petrolet.m corporate income
2 and pet roleum property taxes have b e en added.
Two aspects of Figure 2 are important. First, the shape of the
total petro leum revenue curve indic ates an unmistakable peak followed
--·Figure _'t_:_~ercentage of. ~ener~I_Fund A?propriation from ya:~.~~-S~u~:e_s _
100
90
'9 !L&_qa_s _8,cy_e,r:~ue.t
80 I
70
GO
PER~ENT.
50
40
30-
20
10
' .
1,960 _1 ___ ,2, ____ .. 3 ____ 4 ___ .. 5 6,_, __ .'!.._~ __ 9 ____ ~_97,0 ____ ~ __ 2 _____ ?._. 4 __ 5 __ , __ 6 __ 7 __ 8. ·--~979
: .
. ' ' I ; I ·; i . . . i : i ;·! ; I ' ; ... I J i: .. ; I I I : I •
Source: Alaska Department of Revenue, Revenue Sources, annual, lind Divis ion of Budgat and Manogcmont do ta on an nual
---· ·· · ·· p_r,?pji,a 'on~ •.• ~ .. -.. __ .. · -·-.. -· -.. ·:-·---·-----···-----·· ·-··----------··
...J ' • . ' . : : .
li
::I
0
Cl
N aminal Dollars
6
s
4
0 3
a
0
3
Ill ;'"'"',_....,----...... ,
I '
3
-----Real1978 D ollars
2
I ',
\
'
1980 19U 1990
' ' ....... ....... , . ..... .... __ _
1995 • 2000
.....
2005
Figure 2. A Projection of State of Alaska Petroleum Related Revenues
4
by a long decline . The e xact shape depends upon the total amount of
petroleum found on state lands, the rate of production, the market price
fo r t e production, and the state share of the value of that production.
Pr J ~c tio ns of the height and width o f the curve change constantly , but
the basic s h ape d oes not v ary. Petroleum revenues cannot continue to
increase indefinit ely. At some time, they must peak and btagiri a decline.
\ih eth er this means th e y should be treated as recurrent revenues, since
the decline is presently not projected unt il the 1990s , or a s nonr ecurrent,
since total possible revenues from petroleum are limited by the fini te
r es ource, remains a d ebatable question.
Secon d, when petroleum revenues are defla ted to b e consistent with
the v alue of 1978 dollars (real dollars), their magnitude is reduced by
a subs t antial amount. In 1991, when revenues are projected to peak at
$4.8 billion , their value i n 1978 dol l ars is only $2.1 billion and well
below the peak of $2.3 billion in real dollars reached in 1988. In
fact, the $47 b i llion projected betwe en 1980 and 1994 by the Department
of Revenue is about $27 bill ion in present v alue equivalent, that is, if
the State were t o receive it all tod a y in a lump sum p ayme nt (dis counted
8 percent a nnually). In real t e rms, it is still a substantial amount of
revenue; but future r evenues mr.st pay for inflated future e~:pe nditures
and, thus, the real amount is less than the perceived amount.
Within broad limits, it is difficult to be very specific about the
ultimate amount of revenues the State will receive from petroleum because
the rules of the game will constantly be changing . With literally bil-
lions of dollars at stake, the three main beneficiaries of the distribu-
tion of the p roceeds--~ne oil comp anies, the federal government, and the
State of Alaska--will continually be attempting to improve their own
position. Thu s , we Cdn expect t o s e e continuing dramatic changes both
up and down in p e trole um rev e~ue projections in future years, a nd plac-
ing r e liance upon a particular set of projections for planning purposes
shoul d be a vo i d ed . It is important to understand this and the implic a-
tions of this varia b i lity f or decision making.
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s
A significant portion of projected petroleum revenues has already
effectively been spent on existing government programs projected to
continue into the future. I f state gove rnment expenditures grow only
because o f population increa ses and inflation, then the a mount of
petroleum r evenues annually available for discretionary spenrling is
illustrated in Figure 3 a _s the shaded area, an amount significantly less
3 4 than total revenues, particularly in the early years. '
Although a large portion of projected petroleum r evenues ha s effec-
tively been spent, the amount ava ilable for new programs , investmen t, or
distribution is substantial. At this point, it may be instruct i ve to
recall the situation the state was in as it entered thP. 1970s. Figure 4A
illustrates what a projection in 1970 of no growth in real governme nt
s pending during the d ecade would have produced. General fund appropriations
would h ave gro\vn 11 percent annually, while the general fund balance
would have increased from $800 million to $3.1 b i llion by 1979, a level
in that year of seven times appropriations . Figure 4B shows in contrast
what actually occurred. Appropria tions grew 22 pe r cent annually and at
the close of the decade real per capita spending was twice the level it
had been in 1970. In spite of the petroleum reserves tax, the general
fund balance was substantially below t he level of current appropriations.
Thus, if past events are any indicati on of future behavi or, growth of
government will substantially reduce the amount of petroleum revenues
available from the level depicted in Figure 3.
HmJ e ver, if it were possible to hold the line on spending in the
operating budget and a lso to maintain only moderate growth in the
capital budget, then a healthy fiscal position for the state such as is
illus trated in Figure S could result. The state would experience large
current a ccoun t surpl•tses in real terms throughout the 1980s, lJhich
would only begin to taper off gradually in the 1990s and remain positive
long beyon d the 1990s. The general fund balance could grm.r to nearly
$16 billion in 1978 dollar s. Sub ~equently, it would begin to decline
---General Fund 9urre:1t
Account Surplus
5 :a
4
3
0 2 ...
0 ..
" 3
iii 1
1980 191'.5 1990
6
----Petroleum Reven..1es
199.5 2000
Figure 3. General Fund Current Account Position-Constant Real
Per Capita Expenditures (1978 $)
.. ~
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::: ..
0
Q ....
0 .. r::
0
i
2,000
1,1
800
700
600
500
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o~~~+-T-~-r-+-;--1~
70 7J'n"7374'75767178 #79
------~-----------
General Fund Appropriations
General Fund Balance
Fit:ure 4B. State Appropriations and the
General Fund Balance in·the
1970•s: The Actual Record.
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1
(
[
(
I
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I
___ ..... __ ----... ·~--------·--~._... .. ____ _ 3~\00~ I -·t 2,~00-8 l
2,300-
l
2,'200-
.I
2100-
I
2,000-
r
1,900-
1,800-
[
1,700-[
--r 1,600-..
-I -1,500--· .. ...
~
0 -. Q I ... 1,400-0 .. s::
0
::E .1,300-
General Fund Appropriations I ---,. ___
1,200-General Ftmd Balance I
1,100-r
1,000-' l I
I
900-I ( I
I
I
800-I I I -· I
I 700-I I I
I
600-I
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~
II
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II
II
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--Jl
• .. ..
0
Q
....
0
• s::
..2
p:)
16
15
l4
13
12
11
10
9
8
7
6
5
4
3
2
1
0
-
-
'
-
-
-
-
-
-
-
-
-
-
-:-
-
-I ~
...
,~"' -~ ~;:.. ~
i\•
r\ -~J i':-.
I-
1980 1985 1990 1995 2000 2005
9
General Fun d Current
Account Surplus
-----General Fund
Expenditures
General Fund Balance
Figure 5. State Fiscal Pattern-Constant Real Per Capita Expenditures (1978 $)
10
very slotvly as grO\vth of the economy outstrippe d growth in the earning
capacity of the accumulate d fund balance. This tmuld necessitate with-
drawals of general fund principal to meet current expenditures. The
permanent fund would accumulate $2.6 billion in 1990 and $3 billion
by 2000.5
B. Continued Expansion of Government Service Levels
A plausible scenario of government spending increases combi .ed with
the petroleum revenue projections discuss ed above would result in the
fiscal situation depicted in Figure 6A.6 The surplus on curTe nt account
is large during the 1980s, during which time the general fund balance
grows r apidly . Subsequ enlly , the continued grO\,•th of expendi t ures
causes the current account surplus to fall to zero in 1994. The general
fund and permanent funds must then be dra wn upon to sustain government
spending, which the y do through the 1990s. Shortly thereafter, these
funds are u sed up.
Since th e dollar amounts invo~ved are so large and difficult to com-
prehend, the same fiscal situation is portrayed as ratios in Figure 6B.
During the current fiscal year (19SO), the state is experiencing a very
significa nt current account surplus (including the Beaufort lease sale
bonuses as revenues), which may exceed 100 percent of expenditures.
This ratio _rema ins high in the 1980s and drops below 50 percent in 1991.
In that year, the r a tio of the combined funds (general plus permanent)
to expenditures peaks at six times. That is, using these funds alone,
expenditures could be sustained for six years.
C. Scenarios Under Different Conditions
The situation dep i cted in F i gure 6A is only as accurate as the
assumpt ions underlying it. Both th~ pattern of government expenditures
and of petroleum revenues may very well be quite different than assumed.
The operating budget, for example, may grow somm..rhat faster in the early
years, result ing in an expenditure path illustrated in Figure 7. (The
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•
•
r!
" ~
0 ...
0
• s::
0 s
iii
11 -
to -
1990
9 -
-.. •
7 -
6 -
s -
4 -
3 -
2 -J
l -.... ~ f." :-...
0
_, -
-2 -
-3 -
-4 -
-s -
-6 -
-7 -
-· -
1995
,, ,,
;'
·' 2000
, ...
\
\
[\
--
, ,,
I
~
1 • • 1
---General Fund E xpend itures
--General Fund Current Account
Surplus
G eneral Fund Balance
70 OS
Figure 6A. State Fiscal Pattern-Continued Growth of State Government (1978 $)
12
Ratio of General Fund
Current Acco unt llalance
to Expendit~ ·c«~
7
6 ........ ,
/ \
I \
5
I \
I \
Ratio of Gen e ral and
Permanent Funds to
Expenditures
I ' I \
I \
4 I \
I \
I \
I \
3 I \
\
\
\
\
2 ' ' \
\
1 \
\
\
\
0 \
-1 \
\
-2
1980 1985 1990 .1995 2000 2005
. . .
Figure 6B. Fiscal Indicators-Continued Growth of State
Government (Ratios)
. I
13
Continued Growth -----w I Rapid Growth
s "kicker"
4
.. ~
0
3
Q ...
0 .. c:
0
3 ,
l
0
1980 198S 1990 199S 2000 200S
Figure 7. General Fund Exp enditures with and wi thout R a pid
Growth "Ki c k er" in 1982 (1978 $)
14
expenditure path for the previous case is included for comparison.)7
Here, expenditures are expanded to a slightly higher level and then
continue to grow at the same rate as previously. Figure SA illustrates
the fiscal situation which results, while Figure 8B allows comparisons
of the ratios of current account and combined fund balances to expendi-
tur es .in th i s case with that of the previous scenario. A moucst budget
increas e that is sustained in future years reduces the maximum ratio of
fund to expenditures from 6 to about 5, a significant reduction in the
financing cus hion for the state, given the apparent innocuous nature of
the i n creas es in expenditures .
Petroleum revenues reduced after 1Y82 by a 25 percent reduction in
royalties and severance taxe s beginning in 1983 (Figure 9) result in the
fis c al situation depicted in Figures lOA and lOB. Because petroleum
revenues are "leveraged" dollars, a 25 p~rcent reduction in the larger
portion of them8 reduces the maximum size of the cushion of fund bal-
ances by 33 percent, to four times expenditures. It also reduces by
about 20 percent the number of years that the state enjoys a positive
fund balance supported by petroleum revenues.
Altering the assumpt i ons in the opposite direction would have
symmetrical results.
D. Con clusion
If current forecasts of petroleum revenues prove to be accura t e,
governme nt capital and operating expenditures could continue a t their
current level almost indefinitely since earnings on the permanent and
general fund could provid~ a substantial revenue source after petroleum
revenues begin to decline.
Substantial incre a~es in government programs are possible during the
1980s, coincident with current account surpluses and increases in the
general fund balanc e. This grm11th makes both nE.\17 and existing ~ov~rmnent
9 .~ 15
1990.
8 -
1993
7 -
6 -
1985 s-
/
/
4 -/
/
/
/
3 -v ~/
~· General Fund Current
'"' Account . Surplus I
2 -I -----G eneral Fund Expenditures . 19&0 /
G eneral Flmd Bala.'lce I /
1-
i\
I\.
o· 1
-\-I
I
-2-1\
\ I
I\
I -3-~
:! n -4-
0
Q ..... I
0 .,
c:: -s-
0
I ~ I
-6-
' . I
-7-
-e-
I -9-
I -10-
0 .... .. c:::
16
Ratio of General Fund
Cu rrent Accou nt
Balance t o Expenditures
6
5 --~ ....
/
/
/
/
4-/
/
I
/
I
3
I
I
I
I
/
I
2
1
0
-1
-2
-3
1980 198S 1990
' \
\
\
\
\
\
\
\
\
\
' \
\
\
' \
· Ratio of Gen eral a nd
Pennanen t Funds to
Exp nditures
1993 2000 2005
Figure SB. Fiscal Indicators-Rapid Expenditure Growth in 1gs2 1
17
Petroleum Revenues --------Total Revenues
- -- --Petrole um Revenues-
25% Reduction
-·-·--Total Revenues-25%
Reduction
4
3
s :g ,
0
0 .. c:
0 a
Ill
.......... ··. ···· ..
.••..... ··· ·.
! -·--·, · . ........... _. ' ··. I ' ·. .
\ '· '-------... '· ' ........ ', '·
' '· ',, '· .... _ " ---------
··.
·.
0
l980 l98S 1990 199S 2000 200S
Figure 9. Petroleum Revenues and Total Re\·enues with 25%
Reductio n in Royalties and Severances Taxes after 1~82
1978
'
t
• -
7 -
6 -
5 -
1985
4 -
3 -
.
-2-
-·-
-4-
-a -
-9-
-10-
-n-
1?9\>1
/ , , ,
1995 ,
/
/
I,~, / _,_
;.-
"
2000
1\
\
i\
\
18
G eneral Fund Current
account surplus
.
'
-----General Fund Expenditures
General Fund Balance
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0 :;:;
a: c:::
19
Ratio of General Fund
Current Account Balance
to Expenctituxe s
5
4
3
2
1
0
-1
-2
-3
-4
1980 1985 1990
1
1995
\
' \
\
\
Ratio of Gene ral and
Permant-nt Funds to
Expenditures
\
\
\
\
' \
\
2000 200S
Figure lOB. Fiscal Indicators-25% Reduction in Royal ties
and Severance Taxes after 1982
programs potentially vulnerable to cutbacks in the 1990 ~ as current
account balances decline and the funds arc dratm dmm to p ay f •or
gove rnment.
The fis cal future of the state will continue to b e: subje•ct to a m
extraordinary amoun t of uncertainty because of the po ten ti al for vari-
ability in petroleum revenues and the grqwth in gove~nme ~t expenditures.
II. RECYCLING ALASKA'S PETROLEUM \{EALTH
The question of hmv to ma nace Alaskn Is petroleum t•eal ~h will, if
~urrent petroleum rev enue projec tions prove ac cura le, be one of the
continuing p roblems of th e n mv decade. Sinc e the so1.rc e of the wealth
is a finite n a tural resource, it is pxope r to loo { ~t t ~e problem of
wealth mana ~em ent as if the petroleum revenues ware an inheritance.
The first qu estion is haw much of the inheritance should be spent and
how much should be saved , and th e SPcond question is what things shou.J
be bought and into what assets s l .:>•1ld the s e~v ings be put.
The problem is relatively sinple for an individual if he ha s some
idea of how long . _ will live and how mu ch he would like to leave for
his descendants. But for a government, the problem is much more dif-
ficult because it is not clear what life span or number of descendants
should be conside1.ed, or what ·_he size of the inheritance is. In addition,
the distinction between saving and investment, on the one hand, and spend-
ing, on the other, is not well defined.
In this section , a simplif i ed ve1.~1 on of wePlth management is
examined in which the objcctiv~ ic the provision of income to pruvidc a
capability for continued fund i ng of government. Pres en t services arc
fi ·!lanced by withdrawing a portion of t' e "inheritance," anc, future
services are financed by e~rnings generated from the portion of the
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"inheritance" \.rhich is not spent. For simplicity in this section, no
assumptions are JT.a de concerning the form in vhich the inheritanc e is
h eld except that whatever it is, the real rate of return is p ositive,
averaging about 2 percent. It could be a savings account held by the
state or investments owned by the state or with state participation, or
it could be in thf form of investments made by private c i tizens as a
result of receiving a distribution from current surpluses .
With petroleum revenues viewed as an inheritance, a logi~al way to
organize government spending would be to calculate an annui ty, a constant
rea l dolla r amoun t vhich could be annually drawn from the inheritanc ~
and spen t. For illustrating the idea, we can examine the impl ica tions
of annual spe 1ding of $1.4, $1.6, $1.8, and $2 billion from petroleum
revenue s . We a r e not only interested in the resul ting levels of govern-
ment services which these annuities prn vid e , but also in the abiJity of
state govLr nment to finance programs in the futur e fro m earnings generate d
by the ~onies invested rather than spent.
Figure 11 illustrates the distribution of future sources of state
revenu es with continued grm.rth of sta te gove rnme nt. FL•rd earnings are
a major source of revenues into t h e 1990s and beyonJ. If the state were
int~rested in attaining a desired l evel o ~ income in the future from
investmen ts, there is a necessary level of investment in the present
to meet that goal and, with it, a p ossible annual annuity out of the
"inheritance."
In Figure 12, we have plotted the percentages total e x penditures
whic h could be provided by investment earnings for the four spending pro-
grams ($1.4, $1.6, $1.8, and $2 billion) mentioned above. In all cases ,
1995 is the year in which investment earnings account for the lar ~e st
percentage of total expenditures. Figure 12 and Tabl e l indicate that
th c ~e is a dramatic r educt ion in the ability of government to pay for
services out of earnings in the future as the level of spending out of
p etroleum revenues r ises in the present.
22
100
E n d oj!enous R evenues
90
80
70
.. 60
0
:> c:
" > " c: so 0
c ..
" ..
0 40 ~
Pctrol~.>um Revenues
30
20
10
Feder al Grants
198 0 1985 1990 199.5 2000 2005
Figure 11. The Sources of Future State R evenues
(%Distribution)
.. c .. ::: .. =-
23
90
80
70
60
so
40
30
20
10
1.4 Billion Ann uity .-. .•· .
'-··· ...
• ..
·.
.. ·· .. ·.
·· ....
Constant Real Pe r
Capita Spen d int
...
• • .. _1.6 B illion Annuity
•.
·• •. 1 .8 Billion Annuity
.
0 -.J-----..---~---r----,,.----..,·· 2 Bill i ~n A nnuity .
1980 1985 19 90 1995 2000 :zoos
Figure 12. Proportion of State Revenues from Earnings unuer
Various Inves t m ent Strategies (Percent)
24
TABLE 1. THE PROPORTION OF EXP EN DIT URE S I N 1991
FINAKCABL E OUT OF EARNINGS UNDER VARIOUS
ANN UITY SPEND! ·c PROG~~
Real Annual Spending From
Petroleum Rev e nues
(billion $)
1 .4
1.6
1.8
2.0
Earning s/Expenditur es
(percent)
72
5 8
46
37
For exa mp le , if annual spend ing out o f petrole u m revenues we re
$1.4 billion i n r eal t erm s , earnings from investments could fund as
much as 72 p e rc en t of governme nt expenditures in 1991 . If spending
we re $1.6 billion , the maximum contribution of earnings would fall t o
58 percent .
Th e annual level o f inves tm e n t neces sar y t o achie e these earn ings
profiles is shown in Figure 13. For example , to achieve a maximum earn-
ing ca ~acity of 7 2 percent of expenditures , it would b e ne ces sa ry to
i nves t i n some form o f i ncome-earning assets about $1.5 b i llion annually
d ur i ng the period 1980 t o 1985 and n early $2 billion annually during the
second h alf of t he decade. To achieve a maximum of 37 perce nt contribu-
tion of earnings to fund expenditures , i t wou ld be necessa r y t o invest
about $1 .1 b illion annually during the 1980s .
If g overnment e xpen ditures were n o t to grow in t he fut ure and all
excess ~evenues were invested i n earning a 3 se t s , the n earnings from
those assets would be able t o provide a t a ma ximum about 64 p e rc e nt of
r evenues . Th is me~ns that the $1 .4 billion annua l spending rule, wh ich
r esul s i n a maximum earnings potential of 7 2 percent, would b e accom-
panied by a decline i n the r eal l evel of government services with t ime.
25
·~
2
5 Co nstant Real Per
::I Capi ta Spending ~ 0 -t-----.----.----=-:r>-.r:-:--'1'--<:---=, ...
0
1980 198S 1990 199S
·, 1.8 Billio n Annuity
I
2000 200 S
Figur e 13. Annual Investment Levels under Various Investment
(Spending) Strategies (1978 $)
26
The shape of the lines in Figure !2 illustrates one of the major
probl e ms confronting Alaska during the coming years. In each case, the
propor tion of government expenditures that can be financed out of earn-
ings rises for a P omber of years but inevitably begins to decline in
succeeding years. This r esults from the eventual growth of demand for
government services exceeding the rate of growth of earning capacity of
the state a ssets ~hen a portion of those assets are annually wit~drawn
for con s umption.
In ord e r for fu nd earni n gs to contribute a constant propor tion of
revenues to tl1e funding of ex pe nditures, fund e a r n ing~ must increase at
th e same r ate as s tate expenditures. At a minimum , th is will be the
r ate of inflation plus t h a t rate of population inc rease. The rote of
· inflation in the government sector may '"ell be higher than in the pri-
vate sector b ecause of the relative importance of se r vices as a component
of gov .rnmc nt (wh e re proJuc tivi ty gains may lag). Obtaining a portfolio
of investmePts that yields such a high return will be a difficult task,
and it seems clear that th e state wil l n eed t o assume some risk in its
investments . It is only by accepting risk that significant positi ve
returns c a n b e ac hieved over the long run.
This ana lysis also illustra t e s the fact that government spending,
like any type of infusi o n of mon ey into an economy , has a stimulative
effect on employme nt and , ~n the case of a regional economy, on p opu-
lation. Appro ~:irnately half of the increase in population in Alaska
t-1hich occurred during the 1970s was the result of new migrants coming
into the stat e (roughly 6,000 annually). Figu re 14 illustrates the
fact that the high e r annuity spending plans initiated in 1982 h ave both
an imm e diate, positiv e effect on population and a continuing effect
b e cause of t he compounding of grow th from a hi g her base.
The conc lusi on of this section is that futu re e ~r nin gs capac ity
is the l·esult of present investments and that the amo unt of poten t.. ":1 l
future earnings d epends upon both the lt·v el of investme nts made in th
.. c.
0
" "'
IOC
700
0 600
{;
c: • :>
0 f. soo
400
1980
27
1985 1990 \99S 2000 lOO!
2 .0 Billion Annuity
1.8 Bi llion Annuity
1 .6 Billion AnnuiLy
1.4 Bi llion Annuity
Figure 14. Population under Various Investme nt (Spending)
Strategies
28
present and the rate of return on those investments . In order to achieve
substantial earnings capaci ty relative to expenditures i~ the 1990s,
present investment levels mu s t exceed $1 billion annually.
III. RECYC L ING ALASKA 'S HEALTH \HTH EHPLOYNENT
GRO\\'TH AS A CONSID ERATION
Employment growth may be an objective o f wealth management in
addition to the availability of f u ture r e venues . \\!hen employment is
considere d, th ~ ~i st i n c tion betwee n savings and consumption ~n wealth
ma nagement begins to bJ ur. Expenditures \-7hich involve employment gen-
e ration ma y resul t in a positive return to the state in t he form o f
taxes or some othet t ype of revenues. Some of these "investments " may
generate e mp loyment but n o t a mon e tary re turn on the investmen t. These
expenditures may be called investments; b u t in reality, they consume
the earn ing s power of the fund and should properly be identified as
consumption--consumption ~ith the objective of generat i ng employm ent.
At the sa~e t ime , how ·ve r, they do r epresent the creation of a capital
investment with some possible earnings ~otential .
If e mployme nt 5rowth and earnings capacity are dual objectives
of wealth ma nag ement, a tradeoff as illustrated in Figure 15 exists.
The state must choose a combination of e ~ployme n t-creating investments
and other t ypes of investments. Each comb i nati on will resul t in some
level of e a rnings capacity for the fund and some rate of employment
growth suc h as point A. The s hape of the curve illustrates t~o facts.
First , governme nt-i ni tiated investments can s timula t e employmeP.t growth.
Second, as the result of some employment-creating inves t me nts (those to
the left of A), the tutal e a r nings capa c ity of the state \-1111 increase.
For other employme n t -crea ting i~v e t men ts (thos e to the right of A), the
creation of employm e nt is a t the e xpens e of earning po\~cr for the state,
and a trad eo ff exists bet~c e n earning capacity and e mp l o yment.
Ear n ings Capa ci ty
of
Sta te Investmen ts
Figure 15.
A
29
The Jo ~/Earnings Tradeoff
Employment Grot-1th
Wealth managecent with this dual objective requ ires a two-step
process. The first is the ranki n g of pot e ntial investment projects by
employment-generating pote nt ial within a broader ranking by return on
inves tment. Thus, of two projects with an expected 15 percent rate of
return , the one which g~nerates the larger quantity (and quality) o f
employment p e r investment dollar would get the highe;· rank of the tt-~o.
This wou l d d efine the curve shown in Figure 15. The second step wo uld
involve deciding at what point on the curve to locate. Cl ear y , those
investments repres0 nted by the portion of the curve to the left o f point A
should be und er taken because they result in b 0 th a po sitive return on
investment and a positive increment to employment. To the righL of A,
greater stimulation to employment can be generated only wi th a decline
in the abili t y of the government to finance programs out of services.
As points fu r ther to the right are reached, the Jbility of the govern-
m~nt to fund programs must be reduced by larger amou nts to get the same
increment to employment .
30
In this section, we examine a hy o thetical example of an investmem t
policy associated with job creation to isolate som~ of the important
elements involved . We look at an investment policy which, star ting in
1981 , adds 200 new j obs annually to the Ala ska economy under t hree sets
of conditions . The j ~bs are in high-sa]aried manufac turi ng indus tries.
In a ll cas es ana l yzed , the n~~•Jnal return on the investment is 7 percent,
which is assumed to be the equiva lent return which could be obtained on
a nonemploym ent-gene rating investment . In other words, the state col-
lects 7 p ercent on its investment .
The assJmpt~ons of the first case are that:
a. the initiation and operation of the program are costless,
b. there is n o government spending increase assoc iated '-lith
economi c grmvth d e rived from employment stimulation ,
c. the personal income tax schedule is unchanged, and
d . th e approximate annual c orporate income ta x per ne'J
employee is $5,000.
Under these assumptions, by 1985 employment has gro\vn by 2 thousand
due to ~~e mu ltiplier effect. State revenues have risen by $12 million
with h alf of the increase attributable to the corporal~ income t ax and
one -fourth accounted for by the personal income tax. Clearly, the total
return to the state on the investment L R this case is most sensiti ve to
factors causi . variation in the level of corporate tax rec eipts derived
from the project . Since expenditures are unchanged, the general fund
balance incre ases. It accumulates an additional $27 million by 1985
as the result of the positive revenue fl6ws of the previous year~.
In c second case, a further assumption is made that the emplvyme n t
increase c rea t es an influx of migra nts into th0 state to fil] a portion
of the openings, and the d ema nd created by thes e individuals causes an
increase in gover nrnP nt expenditures to the extent that ~h 0s e new migrnnts
rece i v e the same l eve l of service s as present resid e nts .
)]
This r es ults in slightly highe r ,•mpJ oyment inc rea ses (2 . 2 thu usand
in 1985), a nd the add ed em?luyw~nt ge n e r ates a dd i tional r evenues of
$.5 mi llion b y 1985. This increase in tax r~venu es is offse t, hoHeve.,
by a decrease in general fund earnings of $.8 million. The d ec l i ne in
g ener a] fund ea rnings occurs because a portion o f the fund mu s t be cashed
in t o h elp p ay the cos t of the increase in government services. The
r e s~l t is that the g e ner a l fund g rows by only $6 million in 1985 i n
th i s case .
In a th i rd c ase , an additional a ss umpt ion is made that the inves t-
men t prog r am producing the 200 jobs a nnual ly h as a c ost assoc iated with
it wh ich is $50 tho u sa nd (1981 dollar s ) p e r job crea t e d.9 This does not
affect the number of jobs c r ea t e d, bu t it docs signi ficantly alter the
econ omic s of the inves tme n t. The rev e nues wh ich are attributable to t he
income ge n erated by the jobs c r ~a t e d will n ot change, but total r evenues
to the state will decline . This is because t h e state will pay for the
$10 million job-cre ation program out o~ the g ~ne r a! fund, and t te
S l O million t hus expe nd erl will n o t earn i nteres t to b e co l lec ted i n
the next y ear. Th is d eclin e in revenues will not appe ar to b e substan-
tial by 1985 when c u rrent account revenu es are $9 .7 million above the
b ase , but the negative effect on the ~e n e ral fund is sig n ifica nt . By
1985, it h as declined belo\v t he base case b y $59 milli on . These e ffect s
a r e sumr,tarized in Tabl e 2.
Th is h y pothetical ex amp ~e is meant to illustra t e a simFle point
rather th an to presen t an ana ly s i s of particular employment-gene rat i ng
investme nts . It demo nstrates that the income -gene r a ting capa~ility of
employmen t-gen er at i n g investments depends i mpo r tantly upon a f e w fac t ors .
These inc l ude :
a . the revenue-p roduc ing power of che pr0j ec t it s elf
thr ough income taxes o r r esot'i.-c<:: r o yal 1:ies (as oppos e d
to second a ry e ff ec t s which a r ~ t ela tive ly minor),
b. gove r nme nt s pending i n re sponse t o t h e proJec t a nd
po pu l ation-genera ted d em and s , and
c. th e cos t of the employme nt-creati n g inves tm e nt.
32
The se f a ctors d o m1na te th e analysis ; a n~. conse que ntly, any pote ntia l
inves tm e nts mu s t be ana lyze d i n terms of these reve nues and cos t s .
Each mu s t then be compa red to other potential investments on the basis
of income and employm e nt-producing capabilities.
TABLE 2. 1985 I}WACT S OF HYPOTHETICAL
EI-WLOYHENT-GENERATING INVESTIIENTS
Case I Case II
Employme nt (thousa nd) 2.0 2.2
Population (tho us and) 2.4 2.7
State Revenues (million $) 12.1 12.1
Personal Inc ome Tax 2.7 3.0
Corpora te Inc ome Tax 6.1 6.2
General Fund Earnings 1.0 .3
State Expenditures 0 12.7
General Fund Ba lance 26 .8 6 .3
See te~t for case explanatio n .
Case III
2.2
2.7
8.6
3.0
6.2
-3.2
12.7
-59 .3
I
I
I
I
I
1.
33
Not es
More recent estima tes, based upon domestic deregu l a ~ion of crude
oil and higher OPEC prices, are considerably higher. The analysi ~
in this report =~0p ts a conservative approach to the probability
that the Stat'.: of Alaska will actually be the financial b e neficiary
of these developments.
2. The severance tax and royalties comprise about 80 percent of petro-
leum revenues thu s defined.
3. This and all succee ding analyses assume a 25 percent contribution
rate to the permanent fund with no reinvestment of earnings.
4. Wi th minimum earnings growth of government , general fund and
permanent fund soon became a substantial source of state revenue.
This alloto~s larg er amounts of pet·r oleum revenues to be surplus on
current account as time goes by .
S. All permanent fund e ~rnings go i nto the general fund, s0 inflation
begins to eat away at the value of the fund as fund additions de-
cline with declining petroleum revenues.
6. The main assumptions of this scenario are as follows :
a. The operating budge t . grows as follows:
FY 1981
1982
1983
1984+
+2 0 percent
+15 percent
+15 percent
+10 percent
b. The capital budget from all sources and for all uses is
$550 million in 1981 and grows subsequently with the growth
in per&onal income.
c. The personal income tax schedule is reduced by SO percent
in 1981.
d. Strong economic growth (including that of government) causes
etnployment t= grow by 57 percent over the decade of the 1980s
and popula~ion to increase 44 percent ove r the same period.
(In the 1970s, emplo)~ent increased about 78 percent; and
popu l ation, 40 percent.) In the 1990s, groto~th mod e rates to
30 perc ent for employment and 26 percent for population. ,
34
7. Op erat 1 n g expenditure gro wth assumptions:
FY 1981 +20 percent
1982 +20 percent
1983 +15 p e rcent
1984 +15 percent
1985+ +10 percent
8 . Co r porat e i ncome and p roperty tax~~ are assumed unchanged.
9. This is the pre sent value of the future stream of direct govern-
ment co s t s associated with this job-creation program •
..
Filmed at
University of Alaska
Arctic Environmental Information and Data Center
707 A St.
Anchorage, Alaska 99701