Gov. Mike Dunleavy’s proposals are forcing legislators to give extra consideration to cash deficiencies and the potential for mid-year withdrawals from the Permanent Fund Earnings Reserve Account (ERA) in the event of an unexpected deficit.
Every year, the legislature appropriates an amount of money partially based on the Department of Revenue’s (DOR) forecast oil price. But like oil prices, the amount of cash the State has onhand varies throughout the year.
“Even if the State budget is balanced… if it’s balanced when passed, that doesn’t mean that cash flow deficits won’t occur,” State Investment Officer Michelle Prebula testified in a Senate Finance hearing.
Prebula has been with the State since 1993.
“This happens to be my favorite topic,” she said of cash sufficiency.
The State Treasury has a specific definition of cash, Prebula said. It is the general fund cash balance after payments outstanding and cash receipts that haven’t been verified by agencies have been removed. These receipts are considered “in suspense.”
“We don’t consider it available to be spent while it is in suspense until it has been determined whether that money is general fund money or belongs in another fund and gets transferred out,” Prebula explained. “This keeps us from writing more checks we might not be able to cash or over-obligating ourselves.”
In a presentation Thursday, February 28, Prebula showed that there is a lot of cash going out the door in Summer.
While oil and gas property taxes arrive in June, at the end of the fiscal year, debt service payments go out in July. That is also when construction workers need to be paid for capital projects.
“We have a very seasonal flow to our cash,” Prebula said. “We see the bulk of our expenditures early in the [fiscal] year, but we see a lag in our revenues. The vast majority of our revenues come at the end of each month, or quarterly for corporate.”
In July of 2018, the start of the current fiscal year, the State went from having $800 million in available cash to about $300 million after a quarterly payment to the Public Education Fund that goes out to school districts.
According to a memorandum of understanding (MOU) between DOR, the Department of Administration (DOA), the Office of Management and Budget (OMB), and the attorney general, any time the State’s available cash drops below $400 million for five business days, a transfer from savings must be made.
To compensate for the expenditures in July, DOR transferred $700 million from the Constitutional Budget Reserve (CBR) savings account to the general fund.
DOR Commissioner Bruce Tangeman told Senate Finance that was a conscious choice because, even though the legislature authorized a structured draw from the ERA of $2.7 billion, the ERA earns higher interest than the CBR. It makes sense to leave money in the ERA as long as possible and instead draw down the CBR.
“That’s worked quite well,” Tangeman said of the prioritization.
Dunleavy Budget Leaves No Place to Go Except Permanent Fund
“What is the appropriate size of the CBR? How low can we let it go and still be comfortable?” Tangeman asked.
The CBR currently sits at $1.7 billion, about as low as DOR is comfortable.
Historically, the legislature has placed language in the budget that directs DOR to access the CBR in the event of an unexpected deficit or cash flow problem.
However, in FY 1999, the legislature capped the CBR amount at $700 million just before oil prices dropped to $9 per barrel.
“We blew through that $700 million very quickly in several months,” Prebula said.
The legislature had to come back in special session to raise the cap.
“We like to think of our budgeting process as providing some level of stability, but really, nothing keeps the price of oil going from the mid-60s right now down to something much lower mid-year,” Sen. Peter Micciche (R-Soldotna) commented.
“Big changes in oil prices like that, I think, are certainly unusual circumstances, but we’ve seen it before, so it’s not unheard of,” agreed Tangeman.
But Dunleavy’s budget is not equipped with the traditional tools to address such a change in oil price.
The MOU recommends first accessing the Statutory Budget Reserve (SBR) if there is a cash deficiency.
Yet Dunleavy’s budget (SSSB 20) would exhaust the $172 million SBR to cover Medicaid costs if the federal government doesn’t approve waivers, something Legislative Finance Director David Teal said is “near certain.”
After the SBR, the MOU recommends tapping the CBR, but again, the Dunleavy budget contains no language allowing access to that account.
It takes three-fourths of each legislative chamber to access the CBR. Leaving the CBR language out prevents a minority from gaining leverage in a budget debate.
The Dunleavy administration has argued that CBR language is unnecessary because the budget is balanced, but that doesn’t allow for contingencies.
Tangeman said the executive branch accesses money as directed by the legislature. The MOU language might allow access to the CBR without a three-quarter vote, but Tangeman said he would have to rely on the Department of Law to determine that.
Without the SBR or CBR, the only other place to turn in the event of a cash deficiency is the Permanent Fund ERA.
“It’s very easy for us to get a 21 and 11 vote, a simple majority in both the House and the Senate, versus a three-quarter vote to access the CBR,” Senate Finance Co-chair Bert Stedman (R-Sitka) noted. “The concern is that we start relying on the Earnings Reserve Account, and diminish or deplete the Constitutional Budget Reserve and the Statutory Budget Reserve, and use it for budgetary purposes, rather than make the hard decisions.”
Market Volatility, Potential Recession Could Also Hamper Cash Flow
Even with Dunleavy’s dramatic budget cuts, DOR forecasts more time in FY 2020 hovering at or below the $400 million mark than it does in the current fiscal year.
“The only thing we know about an estimate is that it’s wrong right off the bat,” Prebula advised Senate Finance. “Cash forecasting is an art, and the thing we know first about it is that it’s wrong. It’s going to be different. The direction and magnitude of that difference is unknown.”
Senate Finance members worried Thursday how investment returns could drive downward the amount of available cash.
Sen. Bill Wielechowski (D-Anchorage) asked if DOR is preparing for a recession.
“You can see the recession coming,” acknowledged Chief Investment Officer Bob Mitchell, but he said he is resisting the “Siren song” to change asset allocation in the short term.
“Risk gets rewarded over time,” Mitchell said. “We need to take risk in order to generate return over time.”
The State’s high-risk funds include the Permanent Fund, the Public School Trust Fund, and the Power Cost Equalization (PCE) Endowment Fund.
Between September 30 and December 31, the Permanent Fund lost $3.5 billion. The latter two funds went from positive one-year returns to -5.6 percent returns.
“What a difference a quarter makes,” Senate Finance Co-chair Natasha von Imhof (R-Anchorage) said. “One quarter created several billion dollars of change collectively among all of our funds.”
“What if we see another quarter of poor returns?” she wondered. “When the CBR is as low as it is, and eventually, if our Earnings Reserve Account gets transferred out for a variety of different reasons, we will have less of a cushion collectively to address medium returns if we have a prolonged recession in the market. You couple that with low oil prices, and we are in a heap of hurt. It is important and fiscally prudent to maintain cushion… in the event that we have another quarter like we just had.”
The Permanent Fund has a ten-year target return of 6.55 percent, but it has a standard deviation of 12.5 percent.
von Imhof noted that standard deviation can go either direction.
“Volatility matters, and it’s very material,” she said. “It is imperative to keep the Earnings Reserve Account somewhat protected just so we can weather those high volatilities.”
Additional Demands Placed on ERA When It May Be Needed for Cash
Dunleavy’s budget includes $943 million for inflation-proofing the constitutionally-protected corpus of the Permanent Fund, something von Imhof supports and the legislature has not done in the last three years.
However, Dunleavy has also introduced two bills that would pay the balance of Permanent Fund dividends (PFDs) for 2016-2018. The bills would pull about $2.2 billion from the ERA over three years.
The Senate State Affairs Committee will take public testimony on the bills Thursday evening.
That hearing was clearly on senators’ minds when Tangeman said annual structured draws have stabilized the ERA.
“I can’t help but point out that we’re having a hearing tonight for two bills that the governor has put forward to take additional transfers from the ERA outside of the structured draw to pay back dividends,” von Imhof told him. “[OMB] Director [Donna] Arduin has also stated for the record that it is the administration’s interpretation that transfers from the ERA at any given point for reasons such as these paybacks of the Permanent Fund [dividend] are within the realm of the administration and that that money is available for expenditure.”
To be clear, Arduin testified that Dunleavy considers (contrary to Alaska Supreme Court rulings) the ERA to be a savings account for dividends not subject to appropriation beyond the PFD and the annual structured draw.
However, the $3 billion draw for FY 2020 would be insufficient if recession hits or oil prices drop, leaving no choice but to cover cash deficiencies with additional draws from the ERA, as the budget is currently written.
$1.9 billion of the structured draw would already be allocated for PFDs.
“I think you’ll find the Senate Finance Committee very protective of the Permanent Fund,” Stedman warned DOR.
While Tangeman earlier acknowledged the volatility of oil prices, later in the hearing, he testified that the State’s finances are stable because forecast oil production is relatively flat and price forecasts are conservative.
“I think we’re as stable as we’re ever going to be, certainly as we have been in the past,” he said.
“Would you say that we’re in a fiscal crisis?” von Imhof asked him.
“I would say that we’re in a revenue stream crisis, for sure,” Tangeman replied, adding the current budget size can’t be sustained.
“So if we have a revenue crisis, are you suggesting that we should look at new taxes?” von Imhof pressed.
Tangeman has testified that Alaska will have a broad-based tax someday, but he reiterated Thursday that he believes that can be delayed with smaller budgets.
Political will to tax Alaskans may grow if the State has to dip into the Permanent Fund to cover unexpected deficits in FY 2020.