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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.
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