Standard and Poor’s Ratings Services lowered the outlook on the State of Alaska’s credit rating from “stable” to “negative” on Aug. 18, and gave politicians one year to reorganize the fiscal house before the downgrades accelerate.

Standard and Poor’s wrote that the current budget deficit is inconsistent with the state’s “AAA” rating on its general obligation bonds and its “AA+” on appropriation-backed bonds, but cited the state’s still healthy budget reserves as a bridge that could maintain the high ratings.

However, the ratings agency warned that there is not much time — one year — before it will begin downgrading the state’s credit, and rapidly.

“The outsized reserves have thus far shielded the state’s credit quality from the degradation that the large deficits would inflict on most states’ credit quality,” according to the report. “But the magnitude of the fiscal deficits makes the arrangement unsustainable and, unless corrected, inconsistent with the current rating. Therefore, we would likely lower the rating on the state — possibly by more than one notch — if state lawmakers do not enact measures to begin correcting the state’s fiscal imbalance within the next year.”

Alaska finished the 2015 fiscal year ended June 30 with a deficit of about $3 billion, which was covered by nearly emptying the Statutory Budget Reserve. The 2016 fiscal year deficit is also projected at $3 billion or more, and is to be covered with a withdrawal from the Constitutional Budget Reserve, or CBR.

However, at current projected deficits, the CBR will be depleted within a few years, leaving the state accounts with only the Permanent Fund principal — which cannot be accessed short of a constitutional amendment — and the Fund’s earnings that pay for annual Permanent Fund Dividend check payments.

The Earnings Reserve account had a balance of about $7.15 billion as of June 30, according to the Standard and Poor’s report.

S&P noted the state does have some fiscal flexibility to address its budget shortfall not available to most states: the lack of any state income or sales tax, and the annual earnings from the Permanent Fund.

“By introducing a statewide income or sales tax — even if it were set at a low rate relative to other states — the state could generate several hundred million in unrestricted revenue annually,” according to Standard and Poor’s, which then concluded, “In our view, therefore, the state has sufficient potential fiscal resources — if it can assemble the political will — to restore alignment in its UGF (unrestricted general fund), the state’s main operating fund.

“But, absent a course correction, the time horizon before which the state’s current fiscal trajectory could undermine its credit quality is now within our outlook window of one-to-two years.”

The Aug. 18 report also cited oil tax exploration credits as a budget item that could be used to address the gap based on their “mixed results” in return on investment to the state.

The report also acknowledges political atmosphere in Alaska that will make such choices tougher, calling the last legislative session that dragged on through two special sessions “contentious.”

“In our view, it would be a significant political achievement for the state’s lawmakers to reach agreement on any one of the fiscal reforms mentioned above,” the report stated. “But closing the fiscal gap likely will require a much bigger lift — assembling what amounts to an overhaul of the state’s overall fiscal structure.

“Repairing the state’s fiscal structure is likely to be politically difficult because, ultimately, it requires lawmakers to impose a certain degree of fiscal austerity on state residents. It almost certainly involves some combination of trimming the dividend, raising taxes, and additional spending reductions. Nevertheless, challenging as it may be, we believe there is a path to fiscal sustainability for Alaska given its significant budget reserves prudently amassed during the prior era of higher oil prices.”

Andrew Jensen can be reached at andrew.jensen@alaskajournal.com.