Alaska Is Struggling but All Is Not Lost

Alaska’s economy will not rebound overnight, but the policies recommended here can help, and future tax reform should help stabilize the government’s tax base relative to what it faces today.

America’s economy is growing at a slow yet steady pace, but Alaska is not doing so well. Its GDP has been declining for years and it’s currently in a recession. The shale oil boom and low oil prices have been a boon for most of us, who get cheaper gas and energy as a result, but for Alaskans, low profits in the oil industry are a source of economic hardship.

Both Alaska’s economy and tax revenue are heavily dependent on the oil and gas industry: From 2013 to 2015 mining made up 32% of Alaska’s GDP versus only 3% for the U.S. as a whole. And this doesn’t include all of the other service-sector jobs that exist largely due to the spending of employees and investors in the oil and gas industry. This dependence on oil and gas combined with the decline in oil prices has weakened Alaska’s economy and contributed to a $3 billion budget deficit.

When the U.S. economy is in a recession, both the federal government and the Federal Reserve take steps to soften the downturn, such as tax cuts, fiscal stimulus and expanding the money supply. The effectiveness of each of these policies is debatable, but the general consensus is that expansionary monetary policy can reduce the depth and length of recessions.

But the Fed isn’t going to engage in expansionary monetary policy at the national level to help one state. And unlike the federal government, state governments can’t engage in massive deficit spending without making creditors nervous and driving up their cost of borrowing. So Alaska is largely on its own and it doesn’t have many tools at its disposal.

So what should the people of Alaska do to get their fiscal house in order and grow the economy? I recently submitted testimony to the state’s Senate Labor and Commerce Committee, and these suggestions build on that. The following recommendations are based strictly on economic efficiency. I leave other important considerations, such as equity, to the people of Alaska.

First, they should cut the permanent dividend fund check. Each October, every permanent resident of Alaska is given a check from $1,000 to $2,000—sometimes more—which is paid out from the returns on the state’s previously invested oil revenues. Instead of implementing an income tax, this payment should be cut or even eliminated to help balance the budget.

Unlike the implementation of an income tax, a dividend cut would not discourage work. If anything, it would encourage it. Cutting the dividend has a negative income effect on people since it reduces their income. The typical income tax creates both a substitution effect—the income gained from working relative to not working declines due to the tax—and an income effect. The substitution effect induces people to work less while the income effect induces people to work more, but the net result tends to be less work overall.

During a recession, which is defined as a sustained drop in output, it’s not a good idea to further discourage production and output. Because a reduction in residents’ dividend checks wouldn’t change the cost or benefit of additional work, the substitution effect is zero and the cut only induces more work via the negative income effect.

Both a dividend cut and an income tax would reduce Alaska’s attractiveness as a place to live relative to the status quo, likely causing some emigration from the state. But because it doesn’t discourage work, the dividend cut is still preferred.

Of course, encouraging people to work more will have the largest effect on output when jobs are available. Taxes and the cost of doing business affect economic growth, so to spur hiring and business expansion Alaska should reform its corporate income tax. Alaska has eight corporate income tax brackets, which is far too many, and a top rate of 9.4%, one of the highest in the country.

Cutting this to a flat 3% like North Carolina’s, or even 4% or 5%, would be a drastic improvement. Ultimately only people pay taxes, so if Alaska wants to tax income a better way to do so is by taxing wage and investment income directly via a low, flat-rate income tax (although implementing an income tax during a recession is risky as mentioned previously).

Alaska’s policy makers should also examine the state’s regulatory environment. Excessively complicated or burdensome regulations increase the cost of doing business, so reducing them can help economic growth. And unlike tax reductions, reducing regulations doesn’t directly decrease revenue.

If Alaska still needs money to balance its budget after cutting the permanent fund dividend, reforming the corporate income tax and cutting as much non-critical spending as possible— including eliminating subsidies to oil companies—it should borrow from its rainy day fund. An analysis by economist Erick Elder shows that Alaska has enough money in reserves to weather a recession, and it should use some of this money now to do so.

Finally, relying on taxes from oil and gas extraction is not the best long-term strategy for Alaska, and ultimately it will need to implement structural tax reform. Changes to the rules concerning the permanent fund could make it a viable long-term source of revenue, or the state could implement a broad-base income or sales tax. I prefer a sales tax over an income tax, but if constructed well—only one or two brackets, low rates and few deductions/exemptions—an income tax can work.

Alaska’s economy will not rebound overnight. One study predicts that the recession will last for another three years and that ultimately employment and population will stabilize at significantly lower levels. The policies recommended here can help, and future tax reform should help stabilize the government’s tax base relative to what it faces today.

In the long run, the economic reasons for living in Alaska will likely diminish: Because of its geographic isolation and unique climate it is difficult to foresee Alaska as a place that thrives in the modern knowledge economy. This doesn’t mean that some people won’t live there—it remains an exceptionally beautiful place that is unlike anywhere else in America, and there will always be people attracted to what the state offers. But it does mean a smaller population and a smaller economy overall.

Even a smaller Alaska can still be a great place to live and do business for the people who call it home, and that is what Alaskans should focus on achieving.