-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-02-1001
TITLE: ISTRICT OF COLUMBIA: Fiscal Structural Balance Issues
DATE: 09/04/2002
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GAO-02-1001
A
Report to the Chairman, Subcommittee on the District of Columbia,
Committee on Appropriations, House of Representatives
September 2002 DISTRICT OF COLUMBIA Fiscal Structural Balance Issues
GAO- 02- 1001
Letter
September 4, 2002 The Honorable Joe Knollenberg Chairman Subcommittee on
the District of Columbia House Committee on Appropriations
Dear Mr. Chairman: The District of Columbia has historically faced many
challenges due to its unique circumstances and role as the nation*s
capital. After several years of struggling with financial crises and
insolvency in the early 1990s, the District has significantly improved its
financial condition by achieving five
consecutive balanced budgets, an upgraded bond rating, and unqualified, 1
or *clean,* opinions on its financial statements. More recently, however,
District officials have sounded the alarm that the District faces an
imbalance between its long- term expenditure needs for program services
and capital investment, and its capacity to generate revenues over the
long run. These officials assert that the District faces a fiscal
structural imbalance as a result of several factors, many stemming from
the federal government*s presence in the city, the absence of a state to
provide funding for the state- like services provided by the District, and
restrictions on the District*s tax base. In response to your June 26,
2002, letter, this report provides our
preliminary assessment of several elements of the District*s reported
fiscal structural imbalance. However, we have not yet completed the work
necessary to conclude whether, or to what extent, a fiscal structural
imbalance may exist in the District. Specifically, you asked us to provide
information on the following:
the District*s definition of fiscal structural imbalance and its
contributing factors;
the constraints on the District*s revenue, including the prohibition of
an income tax on nonresidents; 1 An unqualified opinion means that the
financial statements are presented fairly, in all material respects, in
conformity with generally accepted accounting principles.
the District*s estimates of its spending requirements, including its
cost estimates for providing services to the federal government and its
spending for state- like functions;
changes in the District*s financial relationship with the federal
government resulting from the National Capital and Self- Government
Improvement Revitalization Act of 1997 (Revitalization Act); 2 and
alternative approaches to measuring structural imbalance in the
District.
The information being presented in this report is based on our work
performed to date on this issue. We currently have ongoing work in this
area and plan to issue a future report which will provide a more
comprehensive analysis of the District*s reported fiscal structural
imbalance.
Results in Brief Like many cities, the District faces a series of
substantial, long- term challenges to its financial position. The key
question is whether city
officials can provide an acceptable level of services to address the
District*s needs with their current tax base. The District argues that it
faces a fiscal structural imbalance between revenues and its expenditures
that undermines its capacity to meet its current responsibilities. In
contrast with a cyclical fiscal imbalance caused by temporary economic
downturns, the District suggests that its imbalance is longer term and
more fundamental* and therefore, structural in nature. The District*s
estimated measures of fiscal structural imbalance are premised on the
continuation
of current budget policy over a longer term period spanning economic
cycles, but do not consider the results of policy alternatives.
District officials have cited constraints they face in raising revenues as
well as what they assert are unique expenditure responsibilities stemming
from the District*s position as a federal city that must also provide
state- like functions. On the revenue side, unlike state governments, the
District is prohibited by federal law from taxing the incomes of
nonresidents working in the District. District officials also point to the
fact that the District is unable to tax a significant portion of property
due to the federal presence.
2 The Revitalization Act is Title XI of Pub. L. No. 105- 33, 111 Stat. 712
(1997). Public Law 10533 in its entirety is entitled the Balanced Budget
Act of 1997.
While federal tax exempt property does constitute a substantial amount of
property in the District, the federal presence also draws substantial
economic activity which provides the District with additional revenues
from sales and income taxes generally not available to other cities of its
size.
On the spending side, the District officials state that they are uniquely
burdened by the responsibilities of a state and by requirements to provide
services to the federal establishment. However, the District*s estimated
costs associated with providing state- like services are not supported by
detailed analysis and data, and are derived from cost allocation formulas
largely based on the judgment of District officials. Moreover, while the
District does have responsibilities similar to those of many states, it
also has state- like types of revenues. Similarly, the District*s
estimates of its costs for providing services to the federal government
lack detailed support, and do not consider the services provided by the
federal government for its own property in the District.
Perhaps most importantly, the District*s estimates of its fiscal
structural imbalance are premised on the maintenance of the existing level
and costs of services now provided into the future. As a result, the
estimates do not consider the potential for mitigating an imbalance with
cost savings through management efficiencies, reassessing current
policies, and restructuring of key programs. For instance, a 2002 McKinsey
& Company, Inc. study concluded that about $110 million to $160 million of
cost savings
could be achieved annually in such areas as health, human services,
education, and transportation if the District*s costs were brought into
line with those of comparable cities.
The District received some federal relief through the 1997 Revitalization
Act, which required the federal government to take over certain services
in such areas as criminal justice, transferring their financing from DC
taxpayers to the nation*s taxpayers as a whole. In addition, the federal
government assumed financial and administrative responsibilities for one
of the District*s largest fiscal burdens, which it inherited from the
federal government as part of the transition to Home Rule in 1973* its
unfunded
pension liability for vested teachers, police, firefighters, and judges.
Also, the federal government*s share of the District*s Medicaid payments
was increased from 50 to 70 percent. At the same time, the Revitalization
Act
eliminated the federal government*s annual payment to the District, which
had reached $660 million per year. As a result of the above changes, the
District estimates net financial benefits ranging from a low of $79.1
million
to a high of $203 million per year during the period from 1998 through
2002. Although District officials state that the Revitalization Act did
not fully address their challenges, they indicate it was an excellent
first step in
helping the city move toward longer term financial stability. While the
District*s estimates point to many specific factors they do not constitute
a comprehensive assessment of imbalances between expenditures and revenue
capacity. The District has not performed the analysis to determine whether
it has the capacity to provide a level of services comparable to those
provided by other cities with similar needs and costs. As a practical
matter, such an analysis is key to determining the presence of an
underlying structural imbalance in the District*s finances. Compared to
the District*s estimates, this approach has the advantage of not being
tied to current service levels, costs, management approaches, or tax
policies. From the perspective of this more comprehensive, comparative
approach, a jurisdiction could suffer from a fiscal structural imbalance
even if its current budget were balanced* for example, the imbalance would
be reflected in lower services, higher taxes, or deterioration of
infrastructure when compared to averages in other
communities. On the other hand, a jurisdiction with chronic current
deficits may not have a structural imbalance if its deficits were prompted
by spending levels or tax rates out of line with comparable jurisdictions
with similar needs.
At the present time, however, comprehensive data and analysis are not
readily available to say with confidence how the District*s financial
situation compares to that of other jurisdictions. Preliminary indications
suggest that the District would have to sustain a high level of
expenditures compared to other state and local areas to provide at least
an average level of services after adjusting for its unique demographic
profile and costs. However, when compared to other entities, previous
studies suggest that the city also has among the highest revenue capacity,
or the ability to raise revenues from its own sources, even accounting for
the federally imposed constraints on the city*s revenue- raising
authority. Importantly, the two sides of the equation need to be put
together to address whether the District has the revenue capacity to
provide for its unique workload and costs with an average tax burden. Such
a comparative analysis would need to adjust for the fact that the District
is not strictly comparable to any
current jurisdiction in the nation, due to its unique combination of state
and city functions and revenues and its role as the nation*s capital. We
are currently undertaking such an assessment and plan to report the
results of our study in the future.
We have been conducting our work on this issue since February 2002 in
accordance with generally accepted government auditing standards, and our
work is ongoing. 3 The information presented in this report provides our
preliminary assessment of several elements of the District*s estimates of
its reported structural imbalance. However, we have not completed the work
necessary to conclude whether or to what extent a structural imbalance may
exist in the District.
In responding to a draft of this report, both the Mayor and the Chief
Financial Officer (CFO) of the District stated their belief that the
District faces a fiscal structural imbalance. However, they endorsed our
conclusion to analyze this issue further, in greater detail, and with
additional
sophistication to discern the degree to which the District might face a
structural imbalance. We continue to conclude that there is insufficient
information to determine whether and to what degree the District faces a
fiscal structural imbalance. Our ongoing work will provide more
comprehensive information and clarify the appropriateness of additional
information and estimates provided by the District*s CFO. The comments we
received from the District*s Mayor and CFO are reprinted in appendixes III
and IV, respectively, and have been addressed in the report as
appropriate.
Background One of the most significant challenges facing the District is
to maintain the financial viability of the city. Earlier this year,
District officials sounded the
alarm that the District faces an imbalance between its long- term
expenditure needs for program services and capital investment, and its
capacity to generate revenues over the long run. In contrast with a
cyclical imbalance caused by temporary economic downturns, the District
suggests its imbalance is more fundamental in nature. These officials
assert that the District faces a fiscal structural imbalance as the result
of several factors, many stemming from the federal government*s presence
in the city, the
absence of a state to provide funding for the state- like services
provided by the District, and restrictions on the District*s tax base.
District officials have stated that the factors contributing to a fiscal
structural imbalance have existed for years but that their effects had
been masked during recent years of national and regional economic growth
and increased tax revenues.
3 Additional detail on our scope and methodology is presented in app. I.
As shown in figure 1, the District has projected operating budget
shortfalls ranging from $67 million to $139 million between anticipated
revenues and estimated baseline expenditures for each year during fiscal
years 2002 through 2006 if corrections are not made. These projections
assume a
continuation of current tax policies and service levels into the future,
without implementing changes to address the projected fiscal shortfalls.
Figure 1: The District*s Projected Operating Budget Without Corrective
Actions 6,250,000
Expenditures (GAAP adjusted) 6,000,000
$139m $75m
5,750,000
$67m
5,500,000
Revenue $119m
5,250,000
$110m
2002 2003 2004 2005 2006 Fiscal year
Projected expenditures Projected revenues
GAAP * Generally accepted accounting principles. Source: District of
Columbia Chief Financial Officer, January 2002 (unaudited).
The operating deficit projections in figure 1 include the operating budget
only and exclude the capital expenditure budget. Therefore, certain
probable expenditures are not included in the above budget estimates, such
as public schools* infrastructure needs, needed repair of public roads,
and Washington Metropolitan Area Transit Authority (WMATA) capital needs.
District officials have expressed concern that if the fiscal structural
imbalance issue is not addressed, it will cripple the city*s efforts to
maintain financial viability and require the city to make drastic cuts in
its budgets and related services to avoid future deficits.
In addition, a March 14, 2002, study 4 commissioned by the Federal City
Council (FCC) 5 concluded that the District is on a path leading to budget
deficits. The study estimated that without corrective action, the District
could face budget deficits of at least $500 million by fiscal year 2005
due to a substantial decrease in revenue growth and unbudgeted spending
increases in several key areas. 6 The study cited spending for public
schools (including spending for special education), Medicaid, and WMATA as
the most significant drivers of the growth in projected expenditure
levels. The District*s The District*s definition of fiscal structural
imbalance is premised on an
Definition of Fiscal imbalance between projected expenditures necessary to
maintain the
current level of services and revenues that will be raised under current
tax Structural Imbalance
and other revenue policies. Under the District*s definition, a current and
Its Contributing
services analysis assumes the current level of services and revenue
Factors structure as the baseline for concluding whether a fiscal
structural imbalance exists. A current services imbalance can develop for
a variety of reasons, including expenditures growing more rapidly than
expected revenues due to increasing workloads such as number of program
recipients, a rapid growth rate in health care costs, or a decline in tax
revenues. The District also points to its uniqueness and the fiscal issues
stemming from its being the nation*s capital and having the federal
presence, as well as its responsibility for services ordinarily provided
by state government.
4 McKinsey & Company, Inc, A Report to the Federal City Council: Assessing
the District of Columbia*s Financial Position (Washington, D. C.: 2002). 5
The FCC is a nonprofit and nonpartisan organization dedicated to the
improvement of the nation*s capital. FCC was established in 1954 and is
composed of and financed by 150 business, professional, educational, and
civic leaders.
6 As discussed in a later section of this report, the McKinsey study also
points out that the District has opportunities to achieve cost savings
that would potentially mitigate the projected deficits.
Some current services imbalances are cyclical, rather than structural, in
that revenues become insufficient to support existing levels of services
during periods of economic decline but then return to sufficiency when the
economy rebounds. In its August 2001 study, 7 the Center on Budget and
Policy Priorities (CBPP) notes that it is extremely difficult to determine
the
degree to which a fiscal imbalance in any state is structural, rather than
cyclical. The CBPP reported that states are currently facing their worst
financial crisis in 20 years, and they are responding to their budget
shortfalls in a variety of ways. Some are using short- term fixes, such as
tapping into rainy day funds or imposing temporary tax increases or
spending cuts; others are using long- term fixes, such as imposing
permanent tax increases or spending cuts.
The revenue shortfalls projected by District officials for fiscal years
2002 through 2006, if accurate, would represent recurring deficits in the
District*s current services budget position if corrective action is not
taken. These projected shortfalls are premised on the continuation of
current budget policy over a long- term period spanning economic cycles.
They do not contemplate changes in budget policy, nor do they compare the
District*s current budget policy with other jurisdictions. However,
District officials also suggest that their current environment constrains
their ability to respond to the projected imbalance through spending cuts,
tax increases, or borrowing. For example, District officials point to
deferred infrastructure improvements in public schools, roads, and
utilities as the legacy of the long- term presence of a structural
imbalance, low levels of service delivery in some programs, such as public
education, and high tax
rates in comparison to other states and local jurisdictions. Although
District officials have not formally estimated the size of their reported
fiscal imbalance, they have cited the following expenditure
responsibilities as the primary factors contributing to such an imbalance:
the District is not directly compensated for services provided to the
federal government such as public works and public safety, which the
District values at $240 million annually;
7 Center on Budget and Policy Priorities, State Responses to Tight Fiscal
Conditions: Short Term Fixes May Backfire if the Economy Does not Soon
Recover; Cyclical Downturn Masks Structural Problems in Some States
(Washington, D. C.: 2001).
the District is responsible for state- like services such as human
services, mental health services, Medicaid, and the University of the
District of Columbia, which the District values at $487 million annually;
and
the District estimates that approximately 400, 000 out- of- state
vehicles travel on city roads per day and do not pay for road repair the
District values at $150 million per year. 8 District officials also cite
the following factors as contributing to limited revenue- raising
capacity: 9
66 percent of the income earned by employees working in the District
cannot be taxed by the District because the employees are nonresidents;
42 percent of the real property (or 27 percent of assessed property
value) in the District is owned by the federal government and is thus
exempt from taxation; 10
an additional 11 percent of real property (excludes District- owned
property, but includes nonprofit organizations and embassies) also is tax
exempt;
District buildings have congressionally imposed height restrictions 11
that have reduced the population and the economic density; and District
tax rates and burdens on households and businesses are high in
comparison to Virginia and Maryland and its tax base is limited, thus
making it difficult to expand the tax base.
8 These figures were provided to us by the District. We did not audit or
verify the data. 9 The figures relating to nonresident income and real
property were provided to us by the District. We did not audit or verify
the data. 10 These figures were provided to us by the District based on
real property tax records. We did not audit or verify the data.
11 DC Code, 2001 Ed. S:S: 1- 206.02 (6) and 6- 601.05.
Constraints on the The District faces some real constraints on revenue.
The District, like all
District*s Revenue state and local governments, is unable to tax property
owned by the federal
government. District officials say they face a particular hardship because
a Include Tax- Exempt larger proportion of their property is owned or
specifically exempted by
Property and Federal the federal government than is the case with most
jurisdictions. The
Law Prohibiting a District has stated that, according to its real property
tax records, 42
percent of its property is federal property. It is difficult to estimate
the net District Tax on the
fiscal impact of the presence of the federal government or other taxexempt
Income of
entities because of the wide variety of indirect contributions that these
entities have on District revenues and the lack of information on the
Nonresidents
services they use. The presence of tax- exempt entities generates revenues
for the District, even though they do not pay income or property taxes
directly. For example, these tax- exempt entities attract residents,
tourists, and businesses to the District. In addition, employees of the
tax- exempt entities and employees of businesses that provide services to
these entities pay sales taxes to the District. We have found no
comprehensive estimates of these revenue contributions; however, studies
of individual tax- exempt entities suggest that the amounts could be
significant. 12 Further, given the
large portion of the private sector activity in the District that is
linked to the presence of the federal government and other tax- exempt
entities, it is unclear whether commercial property would fill the void if
federally owned property were reduced to the average seen in other cities.
12 See Stephen S. Fuller, *The Economic and Fiscal Impacts of the Proposed
International Monetary Fund Building* and *The Economic Impact of George
Washington University on the Washington Metropolitan Area,* Greater
Washington Research Center (Washington D. C.: 2000).
In addition to the amount of nontaxable property in the District, the
District government, unlike state governments, is prohibited by federal
law from taxing the income earned in the District by nonresident
individuals. 13 States that have income taxes typically tax the income of
nonresidents,
although some states have voluntarily entered into reciprocity agreements
with neighbor states in which they agree not to tax the incomes of each
other*s residents. States that impose income taxes also typically provide
tax credits to their residents for income taxes paid to other states. In
addition, some cities that have income taxes tax the incomes of commuters
who work within their boundaries. These taxes are typically levied at a
low flat rate (most of the ones we identified were between 1 and 2
percent) on city- source earnings. Other cities are not authorized to levy
commuter taxes by their state governments. 14 However, in cases where
cities are not
authorized to levy commuter taxes, the state governments are able to
compensate, if they so choose, by redistributing some of the state tax
revenues collected from residents of suburbs to central cities in the form
of grants to the city governments, or in the form of direct state spending
within the cities. 15 13 Section 602( a) (5) of the District of Columbia
Home Rule Act, D. C. Code, 2001 Ed. 31- 206.02( a)( 5) states that the
District*s Council may not *impose any tax on the whole or any portion of
the personal income, either directly or at the source thereof, of any
individual not a resident of the District.*
14 This general discussion is drawn from the State of Wisconsin,
Legislative Fiscal Bureau,
Individual Income Tax Provisions in the States (January 2001); Advisory
Commission on Intergovernmental Relations, Significant Features of Fiscal
Federalism, volume 1,
(Washington, D. C.: 1995); Carol O*Cleireacain, The Orphaned Capital:
Adopting the Right Revenues for the District of Columbia (Washington, D.
C.: 1997); and District of Columbia Department of Finance and Revenue,
Study of Property, Income and Sales Tax Exemptions in the District of
Columbia (Washington, D. C.: 1995). The range of tax rates, in the
jurisdictions we identified as levying commuter taxes, was verified using
publicly available tax descriptions drafted by the individual
jurisdictions.
15 Grants from a state to city government do not represent the net fiscal
flow between the two jurisdictions. States collect significant amounts of
tax revenue from individuals, businesses, and transactions located in
cities. The net fiscal flow would equal state grants and direct state
spending in a city (excluding any pass- through of federal funds), minus
all state revenues collected in that city.
District officials believe that it is unfair for the federal government to
apply a restriction on their income tax base that does not also apply to
the 50 states. Another argument that is commonly made in favor of removing
this particular restriction on the District*s taxing authority is that it
would enable the District government to defray the costs of providing
public services, such as road maintenance and fire and police protection,
that benefit commuters. A recent study estimated that the average commuter
increased total District expenditures by $3,016 per year, of which about
$90 was for police and fire protection. 16 Some local economists that we
interviewed noted that commuters already contribute to the financing of a
portion of these services, even without a tax on their income. One recent
study estimates that a typical daily commuter to the District pays about
$250 per year in sales and excise taxes, parking taxes, and purchases of
lottery tickets. 17 Another study suggests that spending by commuters
supports many jobs for District residents who are subject to the city*s
income tax. 18 We were unable to find data on the amount of taxes paid
directly by commuters, the tax revenues attributable to jobs supported by
them, or the amount of money that the District must spend to extend
services to them, nor have we assessed the accuracy of the estimates cited
above. Consequently, we cannot determine conclusively whether the net
fiscal impact of commuters in the absence of a commuter income tax is
negative or positive.
16 Howard Chernick, *The Effect of Commuters on the Fiscal Costs of the
District of Columbia* (Washington, D. C.: 2002). 17 Philip M. Dearborn,
*Effects of Telecommuting on Central City Tax Bases,* Brookings Greater
Washington Research Program (Washington, D. C.: 2002). The study did not
attempt
to estimate the indirect fiscal contributions that commuters may have
through taxes on their employers.
18 Stephen S. Fuller, *The Economic and Fiscal Impacts of the Proposed
International Monetary Fund Building at 1900 Pennsylvania Avenue, NW on
the District of Columbia,* prepared for the International Monetary Fund
(Washington, D. C.: 2001).
Regardless of the current net fiscal impact of commuters, the District*s
finances clearly would benefit considerably from a tax on nonresidents*
incomes. The ultimate burden of a nonresident income tax for the District
would not necessarily be borne by commuters into the District. The
distribution of the burden would depend on the nature of the crediting
mechanism that would be established under such a tax. For example, if the
District*s tax were made fully creditable against the federal income tax
liabilities of the commuters, as is proposed in the District of Columbia
Fair
Federal Compensation Act of 2002, then the federal government would bear
the cost and would have to either reduce spending or make up for this
revenue loss by other means. However, if the federal income tax credit was
not available, and instead the states of Maryland and Virginia allowed
their residents to fully credit any tax paid to the District against their
state income tax liabilities, then those two states would suffer a revenue
loss (relative to the current situation). The two states could respond to
a District commuter tax by taxing the income of District residents who
work within their jurisdictions or increasing the tax rates on all of
their residents. 19 If the District*s tax were not fully creditable
against either the federal or state taxes, then the commuters themselves
would bear additional tax burden. The District*s Although the District*s
overall warning that it faces structural challenges in
Estimates of Spending balancing revenues and spending requirements should
be taken seriously,
the District*s estimates of its spending requirements have serious
Requirements
limitations. The District does absorb certain costs associated with
supporting services typically provided at the state level as well as with
providing services to the federal government. However, the District*s
estimates of its costs to provide services to the federal government and
its costs of providing state- like services are not supported with
detailed data
or analysis. Also, the District*s estimates do not reflect municipal- type
services provided directly by the federal government. In addition, the
District*s estimates of its fiscal structural imbalance do not include
potential cost savings from improving management efficiency. Further, the
District has developed its budget estimates based on the current level of
services as the baseline going forward. According to District officials,
no
studies have been done to determine the level of services necessary, and
19 The District, Maryland, and Virginia currently have reciprocity
agreements under which each government allows residents to pay income tax
only in the jurisdiction where they reside.
the District continues to struggle to determine the level of services to
provide, given the perceived political barriers to achieving structural
changes in large programs such as public schools, Medicaid, and human
services. Finally, the District has not considered potential savings in
its estimates of its fiscal structural imbalance.
District- Estimated Spending According to District officials, the District
government performs state- like
for State- Like Functions functions that contribute to what it considers a
structural imbalance.
Although the District has costs associated with certain state- like
functions, it is important to note that the District also collects and
retains state- like income and sales tax revenues to fund these functions
and support the activities of some agencies. 20 The District estimated the
cost of state- like functions to be $487 million in fiscal year 2002.
However, this estimate is based on very limited analytic support. Broad
assumptions were made and the analysis was made based on a review of only
one jurisdiction.
To arrive at its cost estimate, the District has identified state- like
functions in 10 different District agencies for fiscal year 2002. To
identify the statelike functions, District officials reviewed the State of
Maryland*s fiscal year 2002 operating budget to identify state funding to
local governments and compared this information with the District*s fiscal
year 2002 operating budget. Based on this review and comparison, District
officials identified
the following 10 District agencies that provide some state- like
functions: Department of Mental Health, Department of Human Services,
Child and Family Services Agency, University of the District of
Columbia, Department of Motor Vehicles, Office of Tax and Revenue,
Department of Insurance and Securities Regulation, 20 Although some cities
do levy income and sales taxes, they are usually at a relatively lower
level than the income and sales taxes at the state level.
Public Service Commission, Office of Cable and Television
Communications, and District of Columbia National Guard. Using the
Maryland state budget as a guide, District officials used their judgment
to assign a *state allocation ratio* to each function in the 10 identified
District agencies. For example, if a function, such as Temporary
Assistance to Needy Families, received more than half of its funding from
the state, then District officials assigned that function a 100 percent
state allocation percentage. If a function received less than half of its
funding from the state, the District did not consider it a state- like
function and gave
it a zero state allocation ratio. District officials considered the Office
of Tax and Revenue both a state and local function and assigned it a 50
percent state allocation ratio. Two other District agencies, the
Department
of Human Services and the Child and Family Services Agency, also had a
combination of state and local functions and therefore had a weighted
state allocation ratio. District officials acknowledged that the state
allocation ratios used to
create their cost estimates were primarily based on their own judgment and
knowledge of state and local programs. Other than providing a summary of
Maryland*s state budget, District officials were unable to provide
additional documentation to support these decisions. District officials
emphasized that, as with any of the cost estimates the District produced
to illustrate what it considers a fiscal structural imbalance, these were
only estimates. They cautioned that these estimates should not be added
together to represent an aggregate cost resulting in a fiscal structural
imbalance. A District official said that these estimates were meant only
to illustrate different ways of understanding the structural imbalance
issues that face the District.
The District*s Estimated The services identified by the District as being
provided to support the
Costs of Services Provided federal government*s presence are primarily
administered by the District*s to the Federal Government
public works and public safety and justice agencies and include: police
protection for federal employees and for federally sponsored or
sanctioned events in the District, fire suppression for federal
buildings,
emergency medical treatment for federal employees, and snow removal
and street repairs on streets used by federal vehicles and
by federal workers commuting to work in the District. District officials
estimated the services provided to the federal government cost the
District up to $240 million annually. However, the District did not have a
detailed list of actual services provided to the federal government to
support its cost estimate. District officials estimated that 27 percent of
the total assessed value of property in the District is owned by the
federal government. As such, District officials have estimated that the
cost of services provided to support the federal government*s presence in
the District is based on 27 percent of the proposed budgets for all of the
District*s public works and public safety and justice agencies. However,
these budgets include functions, such as the Department of Motor Vehicles,
that provide minimal services to the federal government. The District*s
cost estimate for services provided to the federal government
does not consider the services provided by the federal government to the
District or expenditures made by the federal government for its own
property, when in fact, many federal agencies and properties provide for
their own public safety and security and public works services. The
National Park Service, for example, provides an extensive network of
historical, educational, and recreational opportunities within the
District. The federal government provides upkeep, maintenance, and
restoration of facilities including not only well- known national sites
such as the National Mall or Ford*s Theatre, but also parks such as those
on Capitol Hill, including inner city medians, squares, and traffic
circles, as well as other areas that provide urban green space within the
city. According to the U. S. Department of Interior*s fiscal year 2003
budget request, operating costs for these parks will be $59 million.
Federal law enforcement agencies operating within the District include
large forces, such as the U. S. Capitol Police with more than 1, 400
officers, and smaller forces, such as the Smithsonian Institution
Protective Services with an estimated 600 officers. In addition, the
General Services Administration*s Federal Protective Service provides law
enforcement services to some federal properties throughout the District.
These services include a share of police protection from disruptions by
major demonstrations, perimeter security for federal buildings, criminal
investigations to reduce crime, and training of security personnel.
District*s Estimates of The District*s estimates of its fiscal structural
imbalance are premised on
Imbalance Do Not Address the maintenance of the existing level and costs
of services now provided Potential Cost Savings
into the future. The District*s estimates did not address potential cost
savings that could be achieved by improving management efficiency at the
agency level. Reducing expenditures by improving efficiency could reduce
any imbalance between the District*s revenues and expenditures without
negatively impacting program service delivery to its citizens. For
example,
the March 2002 McKinsey & Company, Inc. study on the District*s financial
position 21 concluded that approximately $110 million to $160 million in
annual cost savings could be achieved in health, human services, public
safety, transportation, and the District of Columbia Public Schools (DCPS)
by fiscal year 2005. If achieved, these potential savings could mitigate a
fiscal structural imbalance in the District. However, considerable
uncertainty exists about these estimates. Potentially the District could
also achieve cost savings by correcting problems that have resulted in
disallowed Medicaid costs for the District. The District will not be
receiving over $100 million of Medical Assistance Administration cost
reimbursements for costs incurred in prior years. These cost
reimbursements were disallowed for reasons including failure to file
timely claims or provide adequate support for claims submitted. 22
Nonreimbursed costs are paid out of local funds, not federal funds.
21 McKinsey & Company, Inc, A Report to the Federal City Council:
Assessing the District of Columbia*s Financial Position (Washington, D.
C.: 2002). 22 The District*s 2003 proposed budget submission includes
plans to improve Medicaid cost reimbursement in the future.
Another example where potential cost savings could be achieved is the
DCPS. In the DCPS* fiscal year 2001 Comprehensive Annual Financial Reports
(CAFRs), District officials reported a $64.5 million deficit in locally
appropriated funds. During the fiscal year 2001 audit, the District*s
financial statement auditors identified material weaknesses within the
DCPS accounting and financial reporting processes, such as the monitoring
of expenditures and accounting for Medicaid expenditures related to
services provided to special education students. DCPS could become more
efficient by improving its internal controls over financial accounting and
reporting and reducing the risk of overspending within the DCPS programs.
Public education has been a large driver of expenditures in the District,
representing $1.1 billion of expenditures in fiscal year 2001. 23 Since
1999, the annual increase in the District*s spending for public education
has ranged between 19.4 and 21.9 percent. Clearly, such
spending increases are difficult to sustain. Impact of the
On August 5, 1997, the Congress passed the National Capital Revitalization
Revitalization Act on
and Self- Government Improvement Act, referred to as the Revitalization
Act. The Revitalization Act made substantial changes in the financial the
District
relationship between the federal government and the District of Columbia
as well as in the management of the District government. The District and
several nonprofit public interest organizations have stated that the
Revitalization Act, while not fully addressing the District*s fiscal
challenges, is an excellent first step in helping the District to move
towards long- term financial stability.
The Revitalization Act made the following adjustments in the financial
relationship between the District and the federal government:
eliminated the federal government*s annual federal payment to the
District, and
shifted to the federal government the financial responsibilities and, in
some instances, administrative responsibilities, for the following justice
functions in the District:
23 The District CAFR, exhibit S- 2, p. 115.
incarceration of sentenced adult felons (the Federal Bureau of Prisons
assumed responsibility, and the District*s Lorton Correctional Complex was
recently closed);
the Superior Court, Appeals Court, and Court System (the Pretrial
Services Agency and Public Defender Service functions, and the D. C.
Parole Board were abolished); and
the District Retirement Program covering judges. Also under the
Revitalization Act, the federal government assumed financial and
administrative responsibilities for one of the District*s largest fiscal
burdens, which it inherited from the federal government as part of the
transition to Home Rule in 1973* its unfunded pension liability for vested
teachers, police, firefighters, and judges. In 1998, the federal
government assumed the accrued pension cost of $3.5 billion that existed
at the close of 1997. The District remains responsible for funding
benefits for services rendered after June 30, 1997, and continues the plan
under substantially the same terms. In addition, the Revitalization Act
was part of a larger act* the Balanced Budget Act of 1997* that increased
the federal share of District Medicaid payments from 50 to 70 percent.
Prior to the Revitalization Act, the District had been receiving a federal
payment since the mid- 1800s due to the District*s unique relationship
with the federal government. The Congress recognized that the District*s
ability to raise revenues was affected by a number of legal and practical
limitations on its authority* the immunity of federal property from
taxation; the building height restriction, which has a limiting effect on
commercial property values; the prohibition on the District from passing a
law to tax the income of nonresidents; and the restriction on imposing
sales taxes on military and diplomatic purchases.
Although the Revitalization Act repealed the federal payment to the
District of Columbia, it also authorized a federal contribution. The
Revitalization Act does not present a formula or methodology for
translating the generalized notion of compensating the District for the
federal government*s presence into a predictable dollar amount, nor does
it require that a contribution be made.
The changes to the District*s finances resulting from the Revitalization
Act impacted both the District*s revenues and expenditures. The District
estimates that the net benefit of the Revitalization Act has ranged from a
net positive low of $79.1 million to a high of $203 million per year
during the period 1998 through 2002. A detailed breakout of the estimated
financial impact of the act on the District*s revenues and expenditures is
presented in appendix II.
Fiscal Structural The District*s estimates of its fiscal structural
imbalance point to many
Imbalance: More specific factors but do not constitute a comprehensive
assessment of
underlying imbalances between its expenditures and revenue capacity. The
Comprehensive
District has not yet determined whether even under the constraints they
Approaches Should be
assert, it has the capacity to provide a level of services comparable to
those Explored
provided by other cities with similar needs and costs. The District*s
estimates essentially use a current services approach to analyzing its
fiscal structural imbalance. Even if the District is able to resolve the
measurement and analytical problems discussed in this report, this
approach would be limited because it assumes the desirability and
continuation of current service levels and tax policies. An alternative
approach would measure the existence of a fiscal structural imbalance by
comparing the District*s spending and revenue capacity to levels in
comparable jurisdictions. This approach assesses the ability of the
District to provide at least an average level of services adjusted for its
unique demographic profile and costs at an average tax burden.
The main advantage of this approach is that the measure of fiscal
structural imbalance reflects the underlying social and economic
conditions affecting the cost of providing public services as well as the
underlying strength of the tax base. 24 For instance, this measure takes
into account the specific factors influencing the demand for public
services (e. g., a large number of school age children, road
infrastructure) and its ability to fund these services with a tax burden
on local residents that is comparable to other jurisdictions providing
comparable services.
Under this framework, the structural position of a jurisdiction is not
tied to current service levels, or spending or tax policies. From the
perspective of
24 For additional information on analyzing jurisdictions* expenditures and
capacity, see U. S. General Accounting Office, State and Local Finances:
Some Jurisdictions Confronted by Short- and Long- Term Problems, GAO/ HRD-
94- 1 (Washington, D. C.: Oct. 6, 1993) and Robert
Tannenwald, *Fiscal Disparity Among the States Revisited,* New England
Economic Review (July/ August 1999).
this more comprehensive, comparative approach, a jurisdiction could suffer
from a fiscal structural imbalance even if its current budget were
balanced* in this case, the imbalance would be reflected in lower
services, higher taxes, or deterioration of infrastructure when compared
to averages in other communities. On the other hand, a jurisdiction with
chronic current deficits may not have a fiscal structural imbalance if its
deficits were prompted by spending levels or tax rates out of line with
comparable jurisdictions with similar needs.
At the present time, however, comprehensive data are not readily available
to do such a comparative assessment. Preliminary indications suggest that
the District would have to sustain a high level of expenditures compared
to other state and local areas to provide an average level of services
adjusted for its unique demographic profile and costs. However, when
compared to other entities, the city also has among the highest revenue
capacity, or ability to raise revenue from its own sources, even
accounting for the federally imposed constraints on the city*s revenue-
raising authority. The most recent comprehensive comparison that we found
uses the
Representative Expenditure System (RES) to estimate the relative
expenditure needs of states together with their localities, or in the
terms used in this report, the benchmarked expenditures of the states and
localities. 25 This study indicates that, in 1996, the District*s per
capita relative expenditures were higher than those of any state. However,
this measure has certain shortcomings that could result in understatements
of the District*s relative expenditures.
25 See Tannenwald. The RES approach estimates the amount of money each
state, together with its localities, would have to spend in order to
provide a standard, representative package and level of services.
The two most recent cross- state comparisons of revenue capacity indicate
that the District*s revenue capacity per capita compares favorably to that
of most states. 26 These studies use two fundamentally different measures
of
revenue capacity, both of which largely take into account the fact that
the District is prohibited from taxing the District- source incomes of
nonresidents. For 1999, the most recent year for which the Department of
the Treasury has estimated the Total Taxable Resources (TTR) of states,
the District*s value for this particular measure of revenue capacity
exceeded that of every state, except Connecticut. 27 In 1997 and 1998, the
District*s value was higher than that of every state. The most recent
available study that uses the Representative Tax System (RTS) methodology
for estimating revenue capacity indicates that, in 1996, the District*s
revenue capacity per capita exceeded that of 46 states. 28 However,
results of these studies are imprecise and do not allow for
conclusions on whether the District has a structural imbalance. The
measures of the benchmarked expenditures and revenue capacity used in
these studies are out of date. Moreover, as acknowledged by the author of
the referenced study on expenditures, the estimates of the spending needed
to realize average levels of service do not reflect certain relevant
workload and cost differences across jurisdictions.
Ultimately, the revenue capacity and expenditure needs would have to be
put together to address whether the District has the revenue capacity to
provide for at least average levels of services for its unique workload
and costs with an average tax burden. Such a comparative analysis would
need to adjust for the fact that the District may not directly compare to
any
current jurisdiction in the nation, owing to its unique combination of
state and city functions and revenues. GAO is currently undertaking such
an assessment and will report the results of our study next year.
26 U. S. Department of the Treasury, Office of Economic Policy, 2001
Estimates of TTR
(Sept. 28, 2001), and Tannenwald, pp. 3- 25. 27 TTR is defined as the
unduplicated sum of the income flows produced within a state and the
income flows received by its residents that a state can potentially tax.
28 The RTS approach evaluates tax capacity by estimating the per capita
yield that a uniform, hypothetical, representative tax system would
produce in each state.
Conclusions While it has made significant progress over the past several
years, the District, similar to many other jurisdictions, continues to
face a series of substantial, long- term challenges to its financial
viability. Addressing these
challenges requires continued dedicated leadership to make the difficult
decisions and trade- offs among competing needs and priorities.
Presently, insufficient data or analysis exist to discern whether or to
what extent the District is, in fact, facing a fiscal structural
imbalance. On the revenue side, the District clearly has constraints in
its ability to increase its tax base. However, the District*s estimates of
its possible fiscal structural imbalance have limitations and did not
address the levels or costs of services for its citizens in the long term,
whether such services could be supported by its present tax structure or
tax base, or cost savings that can
be achieved from management efficiencies. The available studies comparing
revenue capacity and expenditures across jurisdictions are imprecise and
some may not be applicable to the District.
As such, the Congress would benefit from more systematic information about
the District as it considers proposals for addressing the fiscal
structural imbalance that the District is currently asserting exists. A
fundamental analysis of the District*s underlying capacity to finance at
least an average service level in relation to its needs can help determine
if there is a fiscal structural imbalance. Such an analysis would provide
a stronger foundation for decision makers at all levels to address the
District*s financial condition.
We currently have ongoing work in this area and plan to issue a future
report with a more comprehensive analysis of the District*s long- term
financial condition. Therefore, we are not making any recommendations at
this time.
Comments from the In responding to a draft of this report, both the Mayor
and the Chief
District of Columbia Financial Officer of the District stated their belief
that the District faces a
fiscal structural imbalance, but agreed that further analysis of the
District*s and Our Response fiscal situation is needed because existing
data and analysis are not sufficient to discern the degree to which the
District is, in fact, facing a structural imbalance. The District
reiterated the general areas it believes are drivers of the reported
fiscal imbalance, and, in the District CFO*s
response, suggested that the annual imbalance was roughly twice the amount
reported earlier this year. However, as we stated in our report, we
concluded that insufficient data and analysis exist to substantiate the
District*s earlier estimates of its reported structural imbalance. In
addition, as stated in our report, the District*s estimates of its costs
for providing services to the federal government and state- like services
lack detailed support and have limitations.
We have work ongoing in this area and plan to issue a future report with a
more comprehensive analysis of the District*s long- term financial
condition. Our future analysis will consider the extent to which the
components of the District CFO*s estimates and other important factors,
including those where the District has advantages and disadvantages
relative to other jurisdictions, impact the District*s overall fiscal
situation. The Mayor and the District*s CFO stated that the District will
support our
efforts by providing necessary information and assistance. We are sending
copies of this report to the Ranking Minority Member of the Subcommittee
on the District of Columbia, House Committee on Appropriations, and to
other interested congressional committees. We are
also sending copies to the Mayor of the District of Columbia, the Chair,
DC Council, City Administrator/ Deputy Mayor for Operations, Chief
Financial Officer, and Inspector General. Copies of this report will also
be made available to others upon request.
Please contact me at (202) 512- 9471 or Patricia Dalton at (202) 512- 6737
or by e- mail at franzelj@ gao. gov or daltonp@ gao. gov if you or your
staff have any questions concerning this report.
Sincerely yours, Jeanette M. Franzel Director, Financial Management and
Assurance
Appendi Appendi xes x I
Scope and Methodology To determine how the District and other
jurisdictions define fiscal structural imbalance, including the factors
that contribute to the District*s reported imbalance, we interviewed and
obtained information about fiscal structural balance
and imbalance from officials in various District offices, analyzed
reports and information received to define a fiscal structural imbalance,
and
analyzed the District*s general fund revenue and expenditures in fiscal
year 2001 and prior years to identify significant fluctuations and
programs that were driving costs. To provide information on the
constraints on the District*s revenues, we
interviewed officials from the office of the District*s CFO and several
local experts on the District*s economy and finances. We also reviewed a
number of studies prepared by the District, independent commissions, and
other researchers that contained information, evaluations, and estimates
relating to these constraints.
To provide information on the District*s estimates of its spending
requirements, we interviewed District officials and analyzed District
budget documents and financial statements. To analyze the services
provided by the District to support the federal government, we interviewed
District officials and analyzed relevant supporting information, such as
budgets and financial plans. We also reviewed relevant information from
the General Services Administration and other federal agencies on the
costs and the types of services the federal government provides to its own
property in the District.
To identify and analyze the functions that the District contends are
statelike functions, we interviewed District officials and requested and
analyzed pertinent supporting information. We also reviewed an April 15,
1997, study by the D. C. Financial Control Board entitled, *Toward A More
Equitable Relationship: Structuring the District of Columbia*s State
Functions.* This study compared the District*s governmental functions to
eight similar cities that were selected based on population size, degree
of urbanization, the ratio of employed persons to total population, and
other factors. In addition, we interviewed several local experts on the
District*s economy and finances to obtain their perspective on the state-
like
functions performed by the District and the expenditures the District
makes related to the federal presence.
To address the question of the financial adjustments to the District of
Columbia*s finances as a result of the Revitalization Act, we reviewed
relevant provisions of the Balanced Budget Act of 1997; 29 relevant
provisions of the Revitalization Act; relevant provisions of the
District of Columbia Home Rule Act; the District of Columbia
Appropriations Acts for fiscal years 1998 through 2002;
analyses of the impact of the Revitalization Act on the District*s
budget prepared by the Congressional Research Service;
the Operating Budget and Financial Plans of the District of Columbia for
fiscal years 1998 through 2002 and the Proposed Operating and Financial
Plan for fiscal year 2003;
prior GAO reports on District government financial operations; and the
Department of the Treasury Accountability Report, Fiscal Years 1998
through 2001. We also met with District officials and obtained their
documentation related to their projected net savings from the
Revitalization Act.
To provide information on the District*s revenue capacity compared to
other jurisdictions, we reviewed and summarized studies from the
District*s CFO*s Office, the U. S. Department of the Treasury, and the
relevant economic literature.
We conducted the work used to prepare this report from February to July
2002 in accordance with generally accepted government auditing standards.
As stated previously, our work on this matter is ongoing. The Mayor and
the CFO of the District of Columbia provided comments on a
29 Pub. L. No. 105- 33, S: 4725( b), 111 Stat. 251 518 (1997).
draft of this report. Those comments are reprinted in appendixes III and
IV, respectively, and have been incorporated in the report as appropriate.
The District*s Estimated Financial Net
Appendi x II
Benefits from the Revitalization Act Tables 1, 2, and 3 present the
District*s calculations of the projected net benefits from the
Revitalization Act on the District*s budget for fiscal years 1998 through
2002. As shown in table 1, the District estimates that the net benefit of
the Revitalization Act has ranged from a net positive low of $79.1 million
to a high of $203 million a year during the period 1998 through 2002.
Table 1: Projected Net Benefit of the Revitalization Act on the District*s
Budget (in millions of dollars)
Fiscal year 1998 1999 2000 2001 2002
Total revenue impact (476.9) (666.9) (667.1) (667. 1) (667.1) Total
expenditure impact 678.0 746. 0 784.6 825.1 870.3 Net benefit 201. 1 79. 1
117.5 158.0 203.2 Net benefit as a % of total
4. 6% 1.6% 2.2% 2.9% 3.8% a general fund revenue Note: Differences due to
rounding.
a Fiscal year 2002 ratio is based on estimated revenues. Source: Fiscal
year 1999 Operating Budget and Financial Plan, Government of the District
of Columbia (unaudited).
Table 2: Estimated Reductions in Revenue as a Result of the National
Capital Revitalization Act (in millions of dollars)
Fiscal year 1998 1999 2000 2001 2002
Loss of federal payment (660. 0) (660.0) (660.0) (660. 0) (660.0) Federal
contribution 190.0 Loss of court fees a (6.9) (6.9) (7.1) (7. 1) (7.1)
Total reductions in revenue (476.9) (666.9) (667.1) (667. 1) (667.1) Note:
Differences due to rounding. a The fees are deposited in the DC Crime
Victims Fund and used to pay the costs of the District*s Crime
Victim program. Source: Fiscal year 1999 Operating Budget and Financial
Plan, Government of the District of Columbia (unaudited).
Table 3: Estimated Reductions in Expenditures as a Result of the National
Capital Revitalization Act (in millions of dollars)
Fiscal year 1998 1999 2000 2001 2002
Adult Felony Prisoners a 169.0 185.0 190. 6 196.3 202.2 Pretrial Services
4.6 4. 7 4.7 4. 8 5.0 Parole Board 5. 8 5.9 6. 1 6.2 6. 4 Court of Appeals
6. 0 6.1 6. 2 6.4 6. 5 Public Defender 7.8 7. 9 8.1 8. 2 8.4 Superior
Court 73.0 74.6 76.0 77.7 80.0 DC Court System 35.2 36.1 37.0 38.0 39.2
Medicaid 136.2 166.2 175. 4 185.1 196.2 Pensions 250.0 269.0 290. 0 312.0
335.9 Debt Service b (9.5) (9.5) (9.5) (9. 5) (9.5) Total reductions in
678.1 746.0 784. 6 825.2 870.3 expenditures Note: Differences due to
rounding.
a Adult felony prisoner savings for fiscal year 1999 are based on the
amount proposed in the President*s fiscal year 1999 budget with a 3
percent growth in fiscal years 2000 to 2002. b Debt service impact is
based on $110 million intermediate- term borrowing in fiscal year 1998,
and
short- term borrowing of $200 million in each year for seasonal cash
needs. Source: Fiscal year 1999 Operating Budget and Financial Plan,
Government of the District of Columbia (unaudited).
Comments from the Mayor of the District of
Appendi x III Columbia
Comments from the District of Columbia
Appendi x IV Chief Financial Officer
(194153)
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a
GAO United States General Accounting Office
Page i GAO- 02- 1001 District of Columbia
Contents Letter 1
Results in Brief 2 Background 5 The District*s Definition of Fiscal
Structural Imbalance and Its
Contributing Factors 7 Constraints on the District*s Revenue Include Tax-
Exempt Property
and Federal Law Prohibiting a District Tax on the Income of Nonresidents
10 The District*s Estimates of Spending Requirements 13 Impact of the
Revitalization Act on the District 18 Fiscal Structural Imbalance: More
Comprehensive Approaches
Should be Explored 20 Conclusions 23 Comments from the District of
Columbia And Our Response 23
Appendixes
Appendix I: Scope and Methodology 25
Appendix II: The District*s Estimated Financial Net Benefits from the
Revitalization Act 28
Appendix III: Comments from the Mayor of the District of Columbia 30
Appendix IV: Comments from the District of Columbia Chief Financial
Officer 31
Tables Table 1: Projected Net Benefit of the Revitalization Act on the
District*s Budget (in millions of dollars) 28
Table 2: Estimated Reductions in Revenue as a Result of the National
Capital Revitalization Act (in millions of dollars) 28 Table 3: Estimated
Reductions in Expenditure as a Result of the
National Capital Revitalization Act (in millions of dollars) 29
Figure Figure 1: The District*s Projected Operating Budget Without
Corrective Actions 6
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Appendix I
Appendix I Scope and Methodology
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Appendix I Scope and Methodology
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Appendix II
Appendix II The District*s Estimated Financial Net Benefits from the
Revitalization Act
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Appendix III
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Appendix IV
Appendix IV Comments from the District of Columbia Chief Financial Officer
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Appendix IV Comments from the District of Columbia Chief Financial Officer
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Appendix IV Comments from the District of Columbia Chief Financial Officer
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