Juneau, Alaska

(907) 699-6788 ed.king@kingecon.com

Another Exploration into the PFD: Part 1

If you haven’t been following along, the amount of the Permanent Fund Dividend (PFD) isn’t just a matter of calculating the earnings anymore.

For the last 4 years, the legislature has moved away from using the traditional formula and has begun determining how much to distribute based on what it thinks the State can afford.

Our Governor believes we should avoid making ad hoc decisions about those payments. He believes following the formula is the best course of action, and that changes to the way the PFD is determined should involve the public. It appears 22 of the 60 members of the legislature agree; and, this has created a deadlock in Juneau.

However, even though most supporters of the “full PFD” (including the Governor) believe in “following the law,” they don’t necessarily believe that the current law is immutable.

Almost everyone in the capital agrees that circumstances have changed since 1983 and that perhaps the law should adapt to our new reality. Most are open to changing the law – with appropriate public involvement.

What’s Next?

Just last week, the majority of legislators agreed to distribute about $1,600 to each Alaskan. The traditional formula would have come out to about $3,000 apiece.

A lot of people are unhappy with this amount. Some believe it’s more than we can afford, others believe we need to pay the amount calculated by the statutory formula.

It’s still unclear what happens next, but a $1,600 PFD is the most likely outcome in my mind.

Additionally, the legislature asked the governor for permission to make changes to the PFD law in another special session. So far, that request has not been granted.

But, regardless of whether the conversation happens this summer/fall, or if it waits until the regular session begins in January, discussions about changing the formula are probably going to happen before the 2020 PFD is decided.

So, now that the legislature is not in session, and before they start diving in again, I feel safe providing some neutral information about the issue. Therefore, I intend to spend the next few weeks looking at the PFD from all sides.

**Disclosure: King Economics Group has two contracts with the State government – one evaluating oil tax changes and another analyzing education funding. We are not being paid to evaluate the PFD and have no stake in the issue. This series (and every other post on this website) is not influenced or paid for by the State government and may even be at odds with the administration’s position. Please remember, all information on this website is intended to inform the public, not to persuade them. So, read accordingly.

An Interesting Question

The first article in this series on the topic of the PFD is inspired by a musing by a member during the bicameral PFD working group meeting on June 28th.

It was something to the effect of “if the PFD statute set up in the 1980’s contemplated a 50% interest by the people, since the state decided to reinvest their share of earnings while the people took theirs as PFDs, might the relationship have changed?”

When I hear comments like this, my economist ears perk up. What the member is asking about is called a “dynamic equity model” in which equity can be diluted when partners contribute different amounts to the business than their equity share requires.

While we don’t actually have the type of relationship being described, and there isn’t actually an equity dilution provision in the agreement if we did, it’s an interesting question.

Equity Dilution on the PFD

For purposes of this mythical world, the “People” is a collection of Alaskan residents. Their share of earnings is distributed among each member.

The “Government” is a non-profit body that provides services for others. Their share can be used to provide those services.

Let’s pretend that these two parties signed an equity agreement in 1986 (there were a lot of changes in the first few years of the dividend program as things got figured out, so let’s start here just for simplicity).

In this imaginary world, the ownership interests in the corporation created to manage the Permanent Fund were established with the signing of the statute that created the PFD as we know it today.

That law distributes 50% of net income to the People (and 50% to the Government by inference). So, we can conclude that each party became a 50% owner in the corporate assets and was entitled to 50% of the net revenues it generates. (Remember, this is all make believe. Chill out.)

How it Works

In the first year of operating under this arrangement, the corporation earned $1 billion on a net asset base of $6.5 billion. That means each party was entitled to a $500 million distribution.

The People decided to take $300 million of its earnings and subsequently passed it on to the residents in checks of $556 each. It reinvested the other $200 million into the corporation.

The Government decided not to take a distribution at all, seeing as they had enough other revenues to pay for the services they provide. So, they left their share of the earnings in the corporation.

At the end of the year, the People now own one-half of the $6.5 billion asset base, plus the $200 million of earnings they didn’t withdraw, plus one-half of the new royalty deposits of $348 million. That adds up to $3.250 + $0.200 + $0.174 = $3.624 billion

The Government now owns one-half of the $6.5 billion asset base, plus $500 million of earnings they didn’t withdraw, plus one-half of the new royalty deposits. That equals $3.250 + $0.500 + $0.174 = $3.924 billion

This means that the Government now owns $3.924 billion out of the $7.548 billion of assets, which increases their equity in the corporation to 52%. Therefore, the People’s equity is diluted down to 48%.

The Result

If you followed this line of thought to today, we have a problem. The actual distributions that were made to the People were based on a continuous 50% equity rate, not a dynamic equity model.

That means that as the People’s equity was diluted, the actual distributions that occurred grew too large to pay out of present year earnings.

In order to pay the PFDs that were actually paid, but just switching to this new equity model, the People would have had to sell part of their equity stake in order to make the payment in most years.

As a result, 2018 would have been the final PFD payment, as the last of their equity would have been sold to pay that $1,100 PFD.

Under this scenario, our FY20 PFD would be almost zero (there’s still a tiny residual interest in new royalty deposits), unless our previous PFDs were smaller.

How much smaller?

In order to avoid selling off equity to pay PFDs, but maintaining the reinvestment of the Government’s share, the PFD would have looked like this (still using the 21% of 5-year earnings method of calculation):

Under this approach, the People would have received smaller PFD checks than they did for the last 30 years, and would currently own 20% of the corporation. If that dynamic equity model was followed, our October 2019 payout would work out to $1,214.

Interestingly, the ad hoc distributions of the last 3 years more or less aligns with this approach. It is as if the Government has already adjusted the equity model, but perhaps without talking to their “business partners” as much as a normal equity partnership would have demanded.

The Upshot

A large portion of the statutory formula is coming from earnings on reinvested earnings, not just on royalty deposits. So, if we accept the premise that half of those earnings didn’t belong to the People, they have been receiving benefits from the actions of their “partners” for many years.

Of course, the current law does not actually provide for a dynamic equity model (or an equity split at all). Therefore, it is justifiable for the People to demand the Government uphold the “contract” the way it was written – not how it could have been.

But, if we accept the 50/50 partnership idea, the Government has a valid argument that the historic equity model disadvantages them in the present. And as such, it might be reasonable to renegotiate that model on a prospective basis.

But, let’s not forget that all of this was a hypothetical. There was never an actual contract between the People and the Government. There is only an existing law that many people believe should be followed until it is changed.

Coming Up

Next week we will explore those “reinvestments” by the Government a little more, along with other deposits into the Fund. Then, we will take a look at this issue from another perspective in two weeks.

I’ll wrap up this series next month with some analysis of various ways the PFD amount could be changed, and I’ll put some numbers to how those changes shake out.

Thanks for reading.

3 thoughts on “Another Exploration into the PFD: Part 1”

  1. The government did take their share though, they just put it into a savings account called the Earnings Reserve and didn’t spend it. Most of us who believe in the good economics of a full PFD don’t have a problem with the government using the money in the Earnings Reserve.

    1. Right. So the principal account would still be owned 50/50 and the Earnings Reserve account would be mostly owned by the “Government.” So, the total Fund ownership would be about 80/20. The problem is that earnings on the earnings reserve balance still get counted toward the PFD.

  2. The legislator’s musing that ‘government’ has a ‘share’ is completely repugnant to the concept of a ‘republic’. The government does not exist for itself. It does not ‘own’ a ‘share’ of anything, nor is it ‘entitled’ to anything. Every penny, whether in the P-Fund or the general fund, belongs to the people. Elected representatives have a fiduciary responsibility to the people. They are managing ‘public treasury’. – they are not spending ‘the government’s’ money.
    It is easy to understand how everyone involved in government, through no fault of their own, develops the corrupt ‘us’ against ‘them’ mindset because they work in an environment where they are isolated from the people they supposedly serve and they wield ‘sovereign’ power. It is an inherently corrupting environment. (google ‘Stockholm Syndrome’)
    The point of ‘citizen legislators’ is to protect elected officials from this corrupting influence by allowing them to interact with common citizens for most of the year. We too need to be careful to avoid creating an ‘us’ against ‘them’ mindset by reminding our selves and our legislators that everybody’s obligation is to be dedicated to the principle that ” that all persons have a natural right to life, liberty, the pursuit of happiness, and the enjoyment of the rewards of their own industry;  that all persons are equal and entitled to equal rights, opportunities, and protection under the law;” as proclaimed by Art. 1, Sec. 1 of Alaska’s State Constitution.

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