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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. The General Accounting Office, the investigative arm of Congress, exists to support Congress in meeting its constitutional responsibilities and to help improve the performance and accountability of the federal government for the American people. GAO examines the use of public funds; evaluates federal programs and policies; and provides analyses, recommendations, and other assistance to help Congress make informed oversight, policy, and funding decisions. GAO’s commitment to good government is reflected in its core values of accountability, integrity, and reliability. The fastest and easiest way to obtain copies of GAO documents at no cost is through the Internet. 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Summary: 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.