This piece first published June 15, 2017, Debtwire Municipals
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Alaska lawmakers are likely to reach a budget agreement ahead of the 1 July start of FY18, avoiding a shutdown, but any resolution will not be a comprehensive solution, said Jonathan King, vice president and senior economist at Northern Economics.

For the second year in a row, Alaska faces a USD 2.5bn budget deficit, as reported. Governor Bill Walker’s (R) proposed FY18 USD 4.3bn general fund spending plan is 51% of the USD 8.81bn in general fund spending in FY14, when oil prices started to decline, creating a gap in the oil-dependent state’s budget, as reported.

In FY17, Walker tried to alleviate the strain on resources by slashing the annual dividend payment to residents from earnings of the state’s Permanent Fund to USD 1,000 from USD 2,100, generating USD 700m in savings, as reported. Walker called for the same solution for FY18, This fiscal year, Walker called for the same solution and also proposed a motor fuels tax.

Walker already called for a special session of the Legislature after lawmakers did not approve a spending plan during the regular session; that 30-day special session ends tomorrow. The governor is likely to call a second special session, said Gregg Erickson, owner of Erickson & Associates, an economic consulting firm.

True fiscal reform is unlikely in the coming fiscal year, with lawmakers opting for a short-term fix and punting the structural problems to the next fiscal year, King said.

Lawmakers are likely to look to the earnings reserve of the state’s Permanent Fund – the state’s USD 59bn constitutionally established savings fund, King said. The fund reported about USD 46.5bn in principal on 30 April, and that is constitutionally protected, but USD 8.2bn in earnings are available for spending, though typically it funds the annual dividend payment Alaskans receive each year and are not traditionally used to fund services.

Alaska has long relied on reserves to balance the budget, using the Constitutional Budget Reserve Fund-—the state’s savings account—for the past two years for fiscal balance, draining the fund to USD 4.81bn as of 31 May from USD 10.1bn at the end of FY15.

The state has an “embarrassment of choices,” Erickson said.

“It’s an ideological battle – two generations of people grew up without paying taxes,” King said, pointing to an anti-tax philosophy among many Alaskan politicians. “People make fun of Kansas (tax cuts) but at least they tax themselves. By going to the earnings reserve of the Permanent Fund … it leaves us yet again with no comprehensive long-term solution.”

Given the rich balances of both spendable reserve accounts, “they could do this another year or two,” King said. The cost of avoiding a shutdown is “fundamentally no progress,” he said.

Walker is preparing for a shutdown – sending layoff warnings earlier this month to employees to prepare them for the possibility of a government closure.

The two chambers are divided on several provisions, and complicating matters further, 2018 is an election year for Walker, members of the House and many members of the Senate, and any tax increase or reduction to the dividend payment will likely have electoral consequences, both King and Erickson said.

“It’s possible they reach some agreement, but the problem is there’s no consensus in the Legislature yet and probably among the population of Alaska and with voters on how to deal with the changes that have occurred in the economy and the way the state finances government,” Erickson said. “The economic crisis is the real crisis.”

If state government shuts down, general obligation and revenue bond debt service payments will be made, but it is currently unclear if appropriation debt payments will be honored, said Deven Mitchell, state debt manager. The state has no debt payments on 1 July, and the next payment is 1 August.

“Appropriation debt is more concerning – but research would be done and we’d be making efforts to pay that debt service payment in the event of a failed budget,” Mitchell said. “I haven’t been able to get together with the Department of Law on yes or no.”

The Alaska situation is one some in the market are watching closely, though the state’s substantial reserves make it easier for the state to find budget balance, said Michael Johnson, co-chief executive officer at Gurtin Municipal Bond Management.

“On one hand, you don’t see other states with the revenue volatility that they do, but on the other hand, you also don’t have states that have the reserve position to withstand the revenue volatility they do, either,” Johnson said. “Put in context – for most other states – the amount of revenue they lost, it would have been a disaster. But they had the reserves to withstand (the problem).”

Alaska is rated Aa1/negative by Moody’s Investors Service, AA+/negative by S&P Global Ratings and Fitch Ratings.

A USD 9.96m tranche of 5% Series 2016B State of Alaska general obligation bonds due 2035 last traded in odd lots at 116.722 to yield 2.739% on 9 June, according to Electronic Municipal Market Access.

by Maria Amante