District of Columbia: Fiscal Structural Balance Issues
Published: 2002-09-04T00:00:00

Fast Facts:

Highlights:
section_title: What GAO Found
paragraphs: 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 or "clean" opinions on its financial statements. More recently, however, District officials have asserted that the District faces a fiscal structural imbalance as a result of several factors, some 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. 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 based 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. 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 they are derived from cost allocation formulas largely based on the judgment of District officials. The District received some federal relief through the National Capital and Self-Government Improvement Revitalization Act of 1997, which required the federal government to take over certain services in such areas as criminal justice, transferring their financing from D.C. 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. Although 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.

section_title: Letter
paragraphs: 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,  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   the constraints on the District’s revenue, including the prohibition of an  income tax on nonresidents;  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); 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.
subsections: section_title: Background
paragraphs: 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.
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.
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 commissioned by the Federal City  Council (FCC) 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. 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.
section_title: The District’s Definition of Fiscal Structural Imbalance and Its Contributing Factors
paragraphs: The District’s definition of fiscal structural imbalance is premised on an  imbalance between projected expenditures necessary to maintain the  current level of services and revenues that will be raised under current tax  and other revenue policies.   Under the District’s definition, a current  services analysis assumes the current level of services and revenue  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.
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, 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;    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.
District officials also cite the following factors as contributing to limited  revenue-raising capacity: 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; 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  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.
section_title: Constraints on the District’s Revenue Include Tax-Exempt Property and Federal Law Prohibiting a District Tax on the Income of Nonresidents
paragraphs: The District faces some real constraints on revenue. The District, like all  state and local governments, is unable to tax property owned by the federal  government.  District officials say they face a particular hardship because a  larger proportion of their property is owned or specifically exempted by  the federal government than is the case with most jurisdictions.  The  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  fiscal impact of the presence of the federal government or other tax- exempt entities because of the wide variety of indirect contributions that  these entities have on District revenues and the lack of information on the  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.   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.
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.   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.  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.
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.   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.  Another study suggests that spending by commuters  supports many jobs for District residents who are subject to the city’s  income tax.  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.
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.  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.
section_title: The District’s Estimates of Spending Requirements
paragraphs: Although the District’s overall warning that it faces structural challenges in  balancing revenues and spending requirements should be taken seriously,  the District’s estimates of its spending requirements have serious  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  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.
subsections: section_title: District-Estimated Spending for State-Like Functions
paragraphs: According to District officials, the District government performs state-like  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. 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 state- like 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,  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.
section_title: The District’s Estimated Costs of Services Provided to the Federal Government
paragraphs: The services identified by the District as being provided to support the  federal government’s presence are primarily administered by the District’s  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.
section_title: District’s Estimates of Imbalance Do Not Address Potential Cost Savings
paragraphs: 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.  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 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.   Nonreimbursed costs are paid out of local funds, not federal funds.
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.   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.
section_title: Impact of the Revitalization Act on the District
paragraphs: On August 5, 1997, the Congress passed the National Capital Revitalization  and Self-Government Improvement Act, referred to as the Revitalization  Act.   The Revitalization Act made substantial changes in the financial  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   shifted to the federal government the financial responsibilities and, in  some instances, administrative responsibilities, for the following justice  functions in the District:    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.
section_title: Fiscal Structural Imbalance: More Comprehensive Approaches Should be Explored
paragraphs: The District’s estimates of its fiscal structural imbalance point to many  specific factors but do not constitute a comprehensive assessment of  underlying imbalances between its expenditures and revenue capacity. The  District has not yet determined whether even under the constraints they  assert, it has the capacity to provide a level of services comparable to those  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.  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  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.  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.
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.  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.  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.
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.
section_title: Conclusions
paragraphs: 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.
section_title: Comments from the District of Columbia and Our Response
paragraphs: In responding to a draft of this report, both the Mayor and the Chief  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  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.
section_title: Scope and Methodology
paragraphs: 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   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 state- like 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;   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   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  draft of this report.  Those comments are reprinted in appendixes III and IV,  respectively, and have been incorporated in the report as appropriate.
section_title: The District’s Estimated Financial Net Benefits from the Revitalization Act
paragraphs: 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.
section_title: Comments from the Mayor of the District of Columbia
section_title: Comments from the District of Columbia Chief Financial Officer
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