The Friday Alaska Landmine column: The myth that will not die

Some claim PFD cuts are the best approach for countering the leakage of dollars from the state through federal taxes. We explain why they never were and why other approaches are better for Alaskans.

A recent exchange helped us realize that an early myth used to argue for cuts in the Permanent Fund Dividend (PFD) is still being repeated by some that we thought, by now, would know better. The myth is that PFD cuts are the best fiscal step for Alaska to take because a “large” portion of the PFD otherwise goes to the federal government in terms of federal income taxes.

In the early days of the PFD debate, when the state was looking for a source of additional revenues to balance the budget, some argued that the state was better off cutting the PFD and retaining for itself a portion of those dollars that would otherwise go to the federal government. In economic terms, the argument was that the state was better off heavily taxing the PFD for its own benefit rather than allowing a portion of the dollars to flow to the federal government through federal taxes.

The problem with the argument was that it looked at the issue in a vacuum, through only one lens: how much state government could realize from the approach. It completely ignored two additional, equally as important lenses: the impact PFD cuts would have on Alaska families (and, through them, the Alaska economy) and whether there were alternative ways of achieving the same revenue objective that better balanced the various impacts.

As we pointed out early on in these columns, there are alternatives that neutralize the adverse impact of the federal tax take and are better for Alaska families. Using either broad-based state sales or income taxes to raise the same level of funds as proposed to be raised through PFD cuts would achieve the same overall economic result for the state as PFD cuts. Between the federal tax deductions such alternatives would generate, which offset some of the federal take, and the amounts the alternatives would raise from non-residents, the state and private sectors would largely come out the same under either the PFD cut or the broad-based tax approach.

Overall, the state economy would bring in as much new money through the alternatives as “leaks” out through federal taxes. There would be no added benefit to the state overall from using PFD cuts.

But as we explained in that column, the latter, broad-based alternatives are clearly superior when viewed from the perspective of Alaska families (and through them, the overall Alaska economy). Either a state sales or income tax would take less out of the pockets of middle and lower-income (which, together, constitute 80% of) Alaska families than do PFD cuts. And, although those alternatives would take more from the remaining top 20% of Alaska families, they would still take much less from them than PFD cuts do from the other 80%. On net, Alaska families (and through them, the overall Alaska economy) would be significantly better off using one or a combination of the broad-based alternatives.

In our view, the concern about the adverse impact of the federal tax “bite” and the myth of the superiority of using PFD cuts to counter it was always a subterfuge used largely by the top 20%. They used it as a cover story for promoting the use of PFD cuts to offset the state’s deficits, not because they really believed that approach was better overall than the alternatives for raising the same amount of money, but because using PFD cuts minimized the level of government take from their pockets. They did not — and to the extent some continue to raise the issue, still do not — go further to consider the impact of such an approach on the remaining 80% of Alaska families or on the Alaska economy overall. The approach was and remains solely a self-serving, top 20% “me first” tool.

As time has passed and more thought has been given to the issue, it has become clear that the alternative of a broad-based state income tax is even more advantageous for both the state and Alaska families than originally thought.

We summarized this updated assessment in a column about this time last year. That column looked at a proposal then-recently surfaced in an op-ed in the Anchorage Daily News by long-time Harvard and Yale-trained Professor Matthew Berman of the University of Alaska-Anchorage’s Institute of Social and Economic Research (ISER).

There, Dr. Berman proposed using the PFD as a refundable state tax credit, much like the “feds already do … with the child tax credit.”

Here’s how it would work: We start paying a state income tax, perhaps a flat percentage — say 15%, for example — of our federal income tax liability. The PFD would be paid as a credit against the state taxes owed. If the PFD exceeded our individual tax liability, the state would issue us a check for the difference. Alaskans earning too little to pay income taxes get the whole PFD. Nonresidents would pay the state a lot more, because they would not get the tax credit. Higher-income Alaskans would come out ahead, too. A PFD tax credit isn’t taxable income, so the feds couldn’t tax it.

In essence, under Dr. Berman’s approach, a large part of the federal tax liability arising out of the PFD would disappear. By converting the PFD to a refundable (and not federally taxable) state tax credit, only a small amount of federal tax liability would remain. But the amount raised from non-residents would stay the same. On net, the state economy would gain money from the approach, not simply hold even with the impact of using PFD cuts.

From the perspective of reducing the federal tax “bite” of Alaska income, Dr. Berman’s approach produces much better results for the state than using PFD cuts. Using PFD cuts, upper-income Alaska families who are most affected by federal taxes still receive some level of PFD, which is still subject to a federal tax “bite.” Under Dr. Berman’s approach, however, most, if not all, of the PFD at upper-income levels would be used as a non-taxable credit against broad-based state taxes. Those in the upper-income brackets would receive credit for the full amount of the PFD; on the other hand, very little, if any, would remain for the feds to tax.

The impact on Alaska families (and, through them, the Alaska economy) is also much better under Dr. Berman’s approach than using PFD cuts. Middle and lower-income (again, 80% of) Alaska families would receive the full PFD and pay out less than is being taken from them currently through PFD cuts. On net, they increasingly come out ahead. Those in the top 20% would pay somewhat more as a share of income, but still less than is being taken from the remaining 80% of Alaska families currently in PFD cuts.

And payments received from non-residents using broad-based taxes would increase the amount of money in the state and, by substitution, reduce the overall cost of government borne by Alaska families.

In short, the state government would continue to receive the same revenues it does using PFD cuts, but much more would remain in the pockets of Alaskan families overall. The difference would come from payments made by non-residents toward government costs, which would reduce the overall contributions required from Alaskans, and, through the credit, significant reductions in the level of federal take.

In our column on Dr. Berman’s proposal, we looked at its impact using our preferred approach of a flat tax. A flat tax is even better from the perspective of reducing the federal tax “bite” than Dr. Berman’s initial thought of basing the state tax on a “percentage … of our federal income tax liability.” That is because more of the PFD would be used as a state tax credit, putting more out of the reach of the feds.

The charts we included in that column showed the change in “Federal leakage” — the amount of the PFD going to the federal government — from the approach that originally triggered the concern. This chart summarizes the differences based on the then-projected Fiscal Year 2022 statutory PFD level of $3,540 ($14,160 for a family of 4) and the flat state tax rate of 6% used in that analysis:

As the chart demonstrates, the amount of “Federal Leakage” under Dr. Berman’s approach (“Using PFD as Credit”) is significantly lower than what occurs if the full PFD is paid without the credit program. It also is less than what occurs using PFD cuts to stem the “leakage.”

In short, if some are truly concerned about the “federal leakage” issue, there are much better solutions for both Alaska families and the overall Alaska economy than continued PFD cuts. The alternatives raise the same amount of money for the state but, by raising money from non-residents and reducing federal leakage even more, do it in a way that takes increasingly less overall from Alaska families and the Alaska economy. While the approaches raise the level of state take from those in the top 20% some, they still take less from them as a share of income than PFD cuts take from the remaining 80% of Alaska families.

In our view, those who continue to push for PFD cuts using the “federal take” argument are being disingenuous, at best. Their goal seems to be to continue to use a cover story to rationalize what, once unraveled, is, at base, a naked effort at protecting the top 20% and non-residents at the expense of the remaining 80% of Alaska and the overall Alaska economy.

Alaska legislators and others seriously focused on finding the best solution to the state’s fiscal situation from the perspective of Alaska families and the overall Alaska economy should push to codify and enact Dr. Berman’s approach. We are prepared to help in any way that we can.

But in the meantime, Alaskans should finally drive a stake through the heart of the “federal take” argument. Relying on a self-serving myth only clouds a debate that urgently requires clarity.