A perennial issue for federal and District of Columbia officials has been determining the proper level of federal assistance to the District. Federal assistance historically has helped the District offset costs associated with its unique status and position. However, according to District officials, this assistance is inadequate. Based on the District’s most recent budget analysis, District officials claim that they will be unable to maintain the District’s current level of services into the future under its current revenue policies. District officials also point to a deeper structural imbalance, stating that they do not have sufficient revenue capacity to meet the high cost of providing residents and visitors with adequate public services. In addition, the District has experienced serious and longstanding management problems. In September 2002, we published an interim report that concluded that the District had not provided sufficient data and analysis for us to determine whether, or to what extent, the District is, in fact, facing a fiscal structural imbalance. To help inform this debate about the proper level of federal assistance, this report (1) assesses whether, or to what extent, the District faces a structural imbalance between its revenue capacity and the cost of providing residents and visitors with average levels of public services, (2) identifies significant constraints on the District’s revenue capacity, (3) examines cost conditions and management problems in key program areas, and (4) studies the effects of the District’s fiscal situation on its ability to fund infrastructure projects and repay related debt. While the District serves as the seat of the federal government, it also serves as home to over a half million people. The District is 61 square miles and had 9,316 residents per square mile in 2000. The District’s primary industry after the federal government is tourism. Other important industries include trade associations, as the District is home to more associations than any other U.S. city. Table 1 describes some of the demographic characteristics of the District and compares them to national averages in 2000. The fiscal relationship between the federal government and the District has been a subject of perennial debate. Although the U.S. Constitution gives the Congress exclusive legislative authority and control over the District as the seat of the federal government, the Constitution did not specifically define the fiscal relationship between the District and the federal government. Accordingly, tension has existed between maintaining some degree of federal control over the District and the desire to grant District residents a say in how they are governed. As a result, local autonomy and federal fiscal support for the District have evolved throughout the last 200 years. Through the 1870s to the present, the federal government has made financial contributions to the District’s operations. Table 2 briefly describes the evolution of this fiscal relationship by highlighting the important milestones since home rule in 1973. Several recent reports address some of the unique challenges the District faces as the nation’s capital, the status of its fiscal health, and the management inefficiencies that continue to affect its programs, costs, and service delivery. While these studies reach similar conclusions about the District’s unique costs associated with the federal presence, as well as its high demand for services, these studies also recognize that the District needs continued management improvements. Table 3 highlights the conclusions reached in several recent reports about the District. After the economic boom of the 1990s, all levels of government are now experiencing serious fiscal challenges and are likely to face even more fundamental ones in the future. The federal budget has moved from unprecedented federal surpluses in the late 1990s to deficits, with the Congressional Budget Office (CBO) now projecting the federal government to run deficits of $246 billion in fiscal year 2003 and $200 billion in fiscal year 2004. At the same time, spending demands are also on the rise, as the federal government deals with funding entitlement programs, such as Medicaid, Medicare, and Social Security, along with new and rapidly increasing health care costs and recent defense and homeland security needs. Similarly, states are experiencing significant, recurring revenue declines— estimates show state budget shortfalls of about $80 billion by 2004. States are not only facing a major decline in revenues—attributed to the recession, steep stock market declines and other factors—but also increased spending in areas like Medicaid due to increased enrollment and health care costs. This shortfall translated into reductions in aid to local governments, hiring and salary freezes, cuts in infrastructure projects and discretionary programs aimed at low-income individuals and families and even across the board spending reductions. Many states have also taken other actions like tapping “rainy day funds” or tobacco settlement money, or raising “sin” taxes. Like those of other state and local governments, the District’s finances have been adversely affected by the recent economic slowdown. The CFO’s office projects that total local source revenues for fiscal year 2003 will be $53.5 million (or 1.5 percent) lower in inflation-adjusted terms than they were in fiscal year 2000. The principal reason for this decline is a significant deterioration in individual income tax revenue. In fact, the decline of $214.1 million in the individual income tax far exceeds the decline in overall revenues. The CFO’s office attributes much of this decline to a steep drop-off in capital gains earned by residents, although the office does not have sufficiently detailed data to quantify the decline in this specific source of income. Sales tax and business franchise tax revenues have also declined, but in smaller absolute amounts compared to the individual income tax. In contrast, revenues from property taxes (the District’s second most important revenue source after the income tax), gross receipts, other taxes, and nontax sources have increased since fiscal year 2000. Table 4 shows the change in revenue from each principal source from fiscal year 2000 through fiscal year 2003. The District’s approved fiscal year 2003 budget was $5.6 billion. As of April 2003, District officials projected that over the long term, continuing current spending and tax policies would lead to increasingly large deficits, growing to $325 million dollars annually by 2007. The Ranking Minority Member of the Subcommittee on the District of Columbia, Committee on Appropriations, United States Senate, and the Honorable Eleanor Holmes Norton, House of Representatives, asked us to study the District’s fiscal position, including whether, or to what extent, the District faces a structural imbalance. To address our requesters’ questions, we used a body of evidence approach that combined quantitative and programmatic analyses to identify any possible structural imbalance. Our approach was not intended to provide a definitive point estimate of any imbalance, rather, it was expected to show whether the District’s ability to provide an average level of services with its given revenue capacity is substantially different from that of most jurisdictions. The approach was also designed to examine cost conditions in key program areas and to identify management problems that could lead to wasted resources. In addition, we attempted to identify the effects of the District’s fiscal situation on deferred infrastructure projects and debt capacity. Our methodology was vetted among key experts, including individuals who designed the underlying methodology and District economists. We revised our methodology based on expert consultation as appropriate. (See apps. I, II, and III for more detail on our overall approach.) Our methodology was based on previous efforts to define an objective measure of a fiscal system’s structural balance. No consensus exists regarding the appropriate level of services and taxation, and this issue has been a matter of perennial debate in every state. For this reason, when public finance analysts have, in the past, compared the underlying or “structural” fiscal position of jurisdictions, they have attempted to estimate objective measures of each jurisdiction’s spending that are independent of that jurisdiction’s particular preferences and policies. Similarly, analysts have estimated measures of revenue capacity that are independent of each jurisdiction’s decisions regarding tax rates and other tax policy choices. As we explain in more detail below, these objective benchmarks for levels of service and for revenue capacity are based on the national average spending and the national average tax rates for state fiscal systems. Consequently, the benchmarks are “representative” of the level of services that a typical fiscal system provides and the tax rates that it imposes on its tax bases. A fiscal system is said to be in structural balance if it is able to finance a representative basket of services by taxing its funding capacity at representative rates. Our use of an average level of services and average tax rates should not be interpreted as an indication that these are the levels of spending and taxation that jurisdictions should seek to provide. Each jurisdiction is an autonomous governmental entity responsible for providing the package of services and level of taxation desired by its citizens. Depending on the preferences of local citizens and their representatives, levels of taxation and the services they support may be higher in some jurisdictions and lower in others. The use of average levels in our analysis should only be thought of as a convenient benchmark against which to gauge relative differences in the cost of providing public services over which local officials have little direct control and as providing an indication of the potential availability of revenue sources from which to finance those costs. Because the District has all the fiscal responsibilities generally shared by state, city, county, and special district governments, we used two baskets of services as benchmarks. The first is a basket of services typically provided by state fiscal systems (the state and all of its local governments), and the second is a basket of services typically provided in more densely populated urban areas. Both baskets include such functions as elementary and secondary education, higher education, public welfare, health and hospitals, surface transportation, public safety, and other public service functions. For the basket of services provided by state fiscal systems, we combined our separate estimates by weighting each spending function by its proportionate share of total spending of the average state fiscal system. For the second basket of services provided by governments serving densely populated urban areas, we combined our separate estimates by weighting each spending function by its proportionate share of total spending of the average urban areas. To calculate the cost of providing an average, or representative, basket of public services, we used the national average per capita spending for each expenditure function as a benchmark for an average service level. For example, the national average per capita spending for elementary and secondary education was $1,338 per capita. We used this figure as a benchmark indicator of an average level of educational services. However, this benchmark has to be adjusted to account for the fact that an average level of spending does not support the same level of service in each fiscal system. To estimate the cost of an average level of services for each state fiscal system, we adjusted our benchmark by cost drivers that reflect specific demographic, economic, and physical characteristics that are beyond the direct control of government officials to affect. For example, we used the number of school-age children (excluding children attending private schools) rather than actual school enrollments to represent the overall scope of government responsibility for elementary and secondary education since actual enrollments can be affected by the decisions of policymakers. Similarly, we used the average wage rate in private sector employment to measure the personnel cost of delivering public services rather than using actual government labor compensation rates since these too are affected by negotiations with public employees and, therefore, reflect government policy choices. Our estimates of the cost of providing an average level of services are likely to understate to some unknown extent the District’s cost of an average service level for a number of reasons. First, by using the average per capita spending of all state fiscal systems as our benchmark of an average service level, by necessity the benchmark excludes any unique public service costs associated with being the nation’s capital. Such unique costs would include, for example, above average costs for crowd control for political demonstrations and increased public safety and sanitation costs based on the disproportionate number of visitors. In addition, data for the various cost drivers (e.g., school-age children and low-income residents) are limited and may not fully reflect all relevant cost drivers affecting a jurisdiction’s cost environment. In addition, a degree of uncertainty exists regarding the relative importance each should have in the overall cost calculation. In these instances, we have generally attempted to choose conservative assumptions so as not to overstate the cost impact of factors used in our analysis. (See app. I for a more detailed discussion of our methodology and examples of instances where conservative assumptions were employed in calculating the cost of providing an average level of public services.) To estimate total revenue capacity, we combined revenue estimates for the two principal sources from which state fiscal systems finance their expenditures: (1) revenues that could be raised from a fiscal system’s own revenue sources and (2) the federal grants that the system would receive if it provided an average basket of services. In the past, two basic approaches have been employed to estimate the own- source revenue capacity of states: (1) those that use income to measure the ability of governments to fund public services and (2) those that attempt to measure the amount of revenue that could be raised in each state if a standardized set of tax rates were applied to a specified set of statutory tax bases typically used to fund public services. Total taxable resources (TTR), developed by the U.S. Department of the Treasury (Treasury), is a leading example of the first type of measure and the representative tax system (RTS), developed by the Advisory Commission on Intergovernmental Relations, is a leading example of the second. Because experts disagree as to which approach is superior, we present separate results using both methodologies. Both RTS and TTR take into account the restrictions placed on the District’s taxing authority. For example, they do not include tax-exempt property or the income earned by nonresidents who work in the District. However, since other states may tax nonresidents’ incomes, those incomes are included in their tax bases. We generally used the actual amounts that state fiscal systems received from the federal government as proxies for the actual amounts that each system would receive if it provided an average basket of services. We do so because grant amounts generally are not likely to change significantly in response to changes in state and local spending choices. However, in the case of the Medicaid program, the federal government provides open- ended matching funds to the District and other state fiscal systems that automatically adjust to changing state policy choices regarding the coverage of their Medicaid programs and the benefits that are provided. In this case, we used an estimate of the Medicaid funding amount that state fiscal systems would likely receive if average Medicaid services were provided. We have not attempted to estimate the extent to which the District and state fiscal systems take advantage of all of their opportunities to receive federal grants. As a consequence, our grant estimates may understate the true potential that these fiscal systems have to receive grants. (See app. II for a more detailed description of the methodology we used to estimate the revenue capacity of state fiscal systems.) To obtain information on federally imposed constraints on the District’s revenue authority, 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. In addition to the quantitative analysis, we conducted a programmatic analysis of the District’s reported structural imbalance by evaluating the levels of service, costs, management, and financing of three of the District’s highest cost program areas: Medicaid; elementary and secondary education; and public safety, particularly police, fire, and emergency medical services. We also conducted case study work on two similar jurisdictions: San Francisco, California and Boston, Massachusetts. These jurisdictions were selected based upon a literature search for empirically based comparisons of cities; opinions of experts of District finances; and a cluster analysis, using demographic and economic variables such as populations, measures of poverty, and number of school-age children. Cluster analysis is a technique that groups units (in this case, cities) into clusters based on their closeness on a set of measures. The case study work was conducted to assess how the District compares to other jurisdictions regarding the types and costs of similar services in Medicaid, education, and public safety, as well as to provide contextual sophistication to the quantitative analysis. In conducting the programmatic work, we collected and analyzed program data and interviewed government officials in the District, California, Massachusetts, San Francisco and Boston governments and in federal agencies responsible for overseeing or providing major funding in these three program areas. Finally, we conducted companion work to identify the effects of the District’s fiscal situation on deferred infrastructure projects and debt structure. To examine the factors involved, we met with officials of the District CFO’s office and Capital Improvement Program (CIP). We also obtained and reviewed prior-year District budget and financial plans, current year expenditure reports for the capital projects, internal studies, and statistics and financial information on the current expenditures for the District’s CIP. Our approach to analyzing the District’s infrastructure projects differed from the approaches used to address the other objectives in this report. Because of the variety of ways infrastructure projects are owned, managed, and reported by other jurisdictions, comparative information on infrastructure across states and local jurisdictions was not readily available; therefore, we did not do a comparative analysis of the District’s infrastructure with states or other jurisdictions. We reviewed the data that the District had available in its annual budget and financial plans and CAFRs, and other documents. To assess the District’s debt service, we obtained and analyzed information from the District’s CFO on the District’s debt levels and projected infrastructure needs. We also compared selected debt service measures for the District to other state fiscal systems. Our work was performed from August 2002 through May 2003 in accordance with generally accepted government auditing standards. To determine if a jurisdiction has a structural deficit, we estimated, for the District of Columbia and the 50 state fiscal systems, the spending needed to provide an average level of public services, the revenues that could be raised with average tax rates and the amount of grant funding the jurisdiction can expect to receive. Our analysis indicated that the District’s cost of delivering an average level of services per capita is the highest in the nation due to factors such as high poverty, crime, and a high cost of living. Our analysis also indicated that the District’s total revenue capacity (own- source revenues plus grants) is higher than all state fiscal systems, but not to the same extent that its costs are higher. The District’s own-source revenue capacity ranked among the top five when compared to those of the 50 state fiscal systems, and its federal grant funding is over two and one half times the national average. To estimate a structural imbalance, we performed several sensitivity analyses to show how our estimates changed as we varied specific judgments and assumptions regarding cost circumstances and the value of specific tax bases. The consistency of our basic result over a broad range of alternative assumptions and approaches led us to conclude that the District does have a substantial structural deficit, even though considerable uncertainty exists regarding its exact size. Using fiscal year 2000 data, our lowest estimate was $470 million and our highest estimate was over $1.1 billion annually. Our analysis did not take into account the unique public service costs associated with being the nation’s capital; however, our analysis did take into account the significant federal restrictions on the District’s taxing authority. The primary reason for the structural deficit is high costs due to conditions beyond District officials’ direct control. To cope with its high cost conditions, the District uses its relatively high revenue capacity to a greater extent than almost all state fiscal systems. However, this relatively high tax burden, in combination with federal grants, is just sufficient to fund an average level of public services if delivered with average efficiency. Using an average of the 50 state fiscal systems as a benchmark, our analysis indicates that the per capita cost of funding an average level of services in the District exceeds that of the average state fiscal system by approximately 75 percent (and is over a third more than the second highest cost fiscal system, New York). In dollar terms, the District would have to spend $2.3 billion more each year to fund an average level of public services compared to what it would have to spend if it faced average cost circumstances. When we adjusted the basket of services to reflect those typically provided in more densely populated urban areas, we estimated that the District would annually have to spend over 85 percent more than the average state fiscal system per capita. As a result, to provide an average level of services the District would have to spend $2.6 billion more than if it faced average cost circumstances. Figure 1 compares the District’s per capita costs of funding an average level of services with those of the five state fiscal systems with the highest costs. We used the U.S. average per capita spending for each specific expenditure function (for example, Medicaid, education, and public safety) as a benchmark for an average service level for that function. We then adjusted this benchmark to account for differing workloads and costs to reflect the fact that an average level of spending does not support the same level of services in each fiscal system because cost conditions differ across locations. For example, adjustments are necessary to reflect the fact that the District must compete with a high-wage private sector in attracting public employees, and high real estate costs push up the cost of government office space, making the provision of public services more expensive than in most states. The adjustments also reflect the fact that the District faces unusually high workloads per capita, such as large numbers of low-income people and high crime rates that increase the cost of Medicaid and public safety. The public service functions that contribute most to the District’s high cost circumstances are Medical Vendor Payments (Medicaid), health and hospitals, and police and corrections. To provide average Medicaid coverage and benefits to its low-income population residents, the District would have to spend about $1,315 per capita, which is more than twice the national average of $551 per capita. (See table 5.) This added Medicaid cost accounts for $437 million of the $2.3 billion difference between what the District would have to spend to meet its high costs and what it would have to spend if it faced only average costs (based on the state basket of services). Similarly, we estimated the per capita cost of providing police services is more than four times the average state fiscal system, adding $436 million to the District’s cost of providing an average level of services annually. One area of the budget where costs are not as high is elementary and secondary education, where, due to a comparatively small percentage of school-age children, the estimated per capita cost of an average level of services is 18 percent above that of the average state fiscal system. The only expenditure function in which the District’s per capita cost of an average service level is estimated to be well below the national average is highways, of which the District has comparatively few miles per capita. Table 5 provides information on the District’s costs of funding services for all functions. The cost estimates shown in table 5 are likely to understate to some unknown extent the District’s cost of an average level of services for a number of reasons. First, by using the average per capita spending of all state fiscal systems as our benchmark for an average level of public services, the benchmark by necessity, excludes any unique public service costs associated with the District being the nation’s capital. Such costs would include, for example, crowd control for political demonstrations that occur disproportionately in the nation’s capital and a disproportionate number of tourists and out of town visitors that impose public safety and sanitation costs on the District’s budget. In addition, limited data are available for the various indicators of workload used in our analysis and there is a degree of uncertainty regarding their relative importance in our overall cost estimates. In these instances, we generally chose conservative assumptions so as not to overstate the cost impact of factors used in our analysis. For example, in adjusting for differences in the cost of living, we took into account only differences in the cost of housing, but due to data limitations, we were unable to take into account other potential sources of such cost variation. Such conservative assumptions likely result in an underestimate of the number of low-income residents in our analysis. For more discussion and examples of instances where conservative assumptions were employed in our analysis, see appendix I. Our analysis indicated that the District’s per capita total revenue and own- source revenue capacities are higher than those of all but a few state fiscal systems. As noted earlier, the District’s total revenue capacity equals the sum of its own-source revenue capacity (the revenue that it could raise from its own economic base), plus the amount of federal grants that the District would receive if it provided a representative level of services. Experts disagree on the best approach for estimating revenue capacity and numerous data limitations exist; thus, in the course of our analyses we made a variety of methodological decisions and assumptions. For this reason, we present a range of estimates for the District’s revenue capacity based on two fundamentally different approaches that have been used in the past. All of the estimates we present include adjustments designed to account for significant constraints on the District’s taxing authority, which are discussed in chapter 3. For one measure of the District’s own-source revenue capacity we used the U.S. Department of the Treasury’s (Treasury) estimates of total taxable resources (TTR). TTR is a comprehensive measure of all income either received by state residents (from state or out-of-state sources) or income produced within the state but received by nonresidents. We also developed a second set of estimates of own-source revenue capacity, using the representative tax system (RTS) methodology. The RTS methodology estimates the amount of revenue that could be raised in each state if a standardized set of tax rates were applied to a set of uniformly defined statutory tax bases typically used to fund public services. Proponents of TTR believe that a measure of revenue capacity should be independent of policy decisions and should avoid judgments about the administrative or political feasibility of taxing particular bases. Proponents of the RTS approach believe that administrative and political constraints should be taken into account, even though it may be subjective to say what is a constraint and what is a choice. In producing our RTS estimates, data limitations compelled us to use a variety of assumptions and, in some cases, several different approaches when estimating individual tax bases. Rather than present results for every possible combination of plausible assumptions, we developed “low” and “high” RTS estimates of own-source revenue capacity. The “low” estimate is the result we obtained when we used all of the assumptions that tended to lower our estimate of the District’s capacity relative to those of the states; the reverse holds for our “high” RTS estimate. (See app. II for additional details.) The two fundamentally different estimation approaches yielded the same basic result—the District’s own-source revenue capacity per capita ranked among the top five when compared to those of the 50 state fiscal systems. According to the Treasury’s TTR estimates, the District’s per capita own- source revenue capacity was 34 percent larger than that of the average state fiscal system in fiscal year 2000. According to our RTS estimates for that same year, the District’s per capita own-source revenue capacity was from 19 percent to 29 percent greater than the average. Although we believe it is likely that the District’s actual revenue capacity falls within the range spanned by both Treasury’s and our estimates, we cannot be absolutely certain that it does. The District’s relatively high own-source revenue capacity, combined with the fact that the District has access to much larger federal grants per capita than any of the state fiscal systems, gives the District a higher total revenue capacity than any of the state fiscal systems. We estimated that, if the District had provided an average level of services in fiscal year 2000, its federal grants would have been more than two and one-half times as large as the average per capita federal grants received by state fiscal systems and over 50 percent more than the second largest recipient of federal assistance, Alaska. Adding these grants to the TTR estimate of own-source revenue capacity yields an estimated total revenue capacity for the District that is 60 percent greater than that of the average state fiscal system. The estimated total revenue capacity for the District, based on the grants plus our “low” RTS estimate, is 47 percent above the national average. Figure 2 compares the District’s total revenue capacity to those of the five state fiscal systems with the highest total revenue capacities. The values in the figure show the extent to which each system’s revenue capacity exceeds the national average, which equals 100 percent. Although the District had the highest total revenue capacity of any fiscal system, the District’s distance from the next highest fiscal systems is not nearly as extreme as it was for the representative expenditure estimates presented previously in figure 1. The District has a structural deficit because its costs of providing an average level of services exceed the amount of revenue that it could raise by applying average tax rates. This result holds regardless of which range of estimating approaches and assumptions we used. We obtained our lowest deficit estimate of about $470 million by combining our lowest estimate of the District’s costs (the one based on the state basket of services) with our highest estimate of the District’s total revenue capacity (the one based on the TTR approach). In contrast, we obtained our highest deficit estimate of over $1.1 billion by combining our highest estimate of the District’s costs (the one based on the urban basket of services) with our lowest estimate of the District’s total revenue capacity (the one based on the “low” RTS approach). While we cannot be certain that the actual size of the District’s structural deficit falls within this range of estimates, we believe that the District's structural deficit is unlikely lower than our most conservative estimate of $470 million for the reasons explained earlier. To better compare the size of the District’s deficit to those of the state fiscal systems, we sought to control for the wide differences in the sizes of the fiscal systems by dividing each system’s deficit (or surplus) by its population and own-source revenues. Table 6 presents the three alternative measures of the deficit and, for each of them, shows how the District ranks against the 50 state fiscal systems. The District’s deficit is larger in per capita terms than that of any state fiscal system for both our higher and lower estimates. The District’s deficit as a percentage of own- source revenue is sixth largest according to our lower estimate, and the largest according to our higher estimate. Figures 3 shows how the District’s structural deficit per capita compares to the state systems with the largest structural deficits. The figure shows that, if the District’s actual structural deficit is close to our lower estimate, then it is not much different than the deficits of most of the state fiscal systems in the top 10 in per capita terms. However, if the District’s actual structural deficit is close to our higher estimate, then it is much larger in per capita terms than the deficits of any state fiscal system. The District’s tax burden (actual revenues collected from local resources relative to their own-source revenue capacity) is among the highest of all fiscal systems, but that burden yields revenues that are only sufficient to fund an average level of services. The District’s actual tax burden exceeded that of the average state fiscal system by 33 percent, based on our lower estimate of its own-source revenue capacity, and by 18 percent, based on our higher estimate of that capacity. (See the first two bars of fig. 4.) The combination of a high revenue capacity and a high tax burden allows the District to fund a very high level of actual spending—$9,298 per capita in fiscal year 2000 compared to a national average of $5,236. However, when the District’s high cost circumstances are taken into account, this high spending level would only be sufficient to provide an average level of services if those services were delivered with average efficiency. Specifically, for the state basket of services, the District’s actual spending is nearly the same as the cost of an average level of public services; for the urban basket of services, its actual spending is about 5 percent below average. (See the last 2 bars of fig. 4.) Moreover, as we discuss in chapter 4, the fact that the District’s aggregate spending is approximately equal to the aggregate cost of an average level of services, suggests that the level of services it actually provides may be below average due to inefficient service delivery and other management problems. Nevertheless, even if the District were to provide its public services as efficiently as a typical state fiscal system, it would still face a structural deficit of $470 million or more. Although the District of Columbia’s (District) own-source revenue capacity per capita appears to be large relative to those of most state fiscal systems, it would be even larger in the absence of several existing constraints on the District’s taxing authority. The most significant constraints are (1) the unique prohibition against the taxation of District-source income earned by nonresidents and (2) the relatively large proportion of the District’s property tax base that is not taxable because it is either owned or specifically exempted by the federal government. District officials say that building height restrictions also limit the District’s property tax base. We are not able to estimate the amount of revenue that the District would gain if these constraints were removed. However, our quantitative analysis indicates that, despite these constraints, the per capita revenue capacities of the District’s income and property taxes are higher than those of all but a few state fiscal systems. In contrast, the District likely has a relatively low sales tax capacity due, in part, to a disproportionate share of sales to the federal government and other exempt purchasers. The fact that the federal government does not pay property or sales taxes to the District does not necessarily mean that the federal presence has a net negative effect on the District’s finances. A significant portion of the private sector activity in the District is linked to the presence of the federal government. Unlike that of any state, the District’s government is prohibited by federal law from taxing the District-source income of nonresidents. The 41 states that have income taxes tax the income of residents of at least some other states. Fifteen states participate in reciprocal nontaxation agreements, but no state has an agreement with more than 6 other states. States that impose income taxes also typically provide tax credits to their residents for income taxes paid to other states. In addition, some cities such as Philadelphia, Detroit, Cleveland, and several other cities in Ohio, 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 those cases the state governments are able, if they choose, to redistribute 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. Critics of this restriction on the District’s income tax base argue that commuters increase the demand for city services and, therefore, should contribute to defraying the additional costs that they impose. Although no data are collected on the amount of money the District spends on commuters, we have rough indications of some of the impacts based on our own quantitative analysis. For example, we estimated that the cost to the District of providing a representative level of police and fire services, solid waste management, parking facilities, local libraries, and transit subsidies in fiscal year 2000 was from $44 million to $77 million more than it would have been if the daily inflow of commuters to the District had only equaled the daily outflow. We cannot separate the impact of commuters from residents on the District's highway costs. Commuters should not have a large impact on the District's costs for other services, such as primary and secondary education or Medicaid. Although commuters impose costs, some local economists we interviewed noted that commuters already do contribute to the financing of these services, even without a tax on their income. Again, no data are collected on the amount of taxes paid directly by commuters or the tax revenues attributable to jobs supported by them. Some rough indications of the revenue contributions are available. One recent study estimated 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 indicates that spending by commuters supports jobs for District residents who are subject to the District’s income tax. It is difficult to estimate the amount of additional revenue that the District would gain if it were allowed to tax the income of nonresidents. The revenue consequences and the distribution of the ultimate burden of a nonresident income tax for the District would depend on how the tax is designed and how nonresidents and neighboring governments respond to it. Particularly important is 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 was proposed in the “District of Columbia Fair Federal Compensation Act of 2002” (H.R. 3923), 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. If 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 might 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 some of the tax burden. Those commuters might try to pass the burden of the tax along to their employers by demanding higher compensation, or they might choose to work elsewhere. This, in turn, would reduce the amount of revenue the District would gain from the tax. Conversely, the higher taxes paid by commuters could result in decisions to relocate to the District to avoid paying the commuter tax. The difficulty of predicting the magnitudes of the various potential policy and behavioral responses makes it difficult to estimate the revenue that the District would gain from a typical tax on nonresidents. Like all state and local governments, the District is unable to tax property owned by the federal government and foreign governments. As the nation’s capital, the District clearly has a higher percentage of its total property value owned by the federal government and by foreign governments than most jurisdictions and, therefore, would benefit more than most jurisdictions if the federal government and foreign governments paid property taxes or made payments-in-lieu-of-taxes. Nevertheless, our quantitative analysis indicates that the District’s per capita property tax base is already larger than those of all but a few state fiscal systems. (See app. II.) There does not appear to be a strong basis for concluding that the District’s commercial property tax base is negatively affected by the federal presence. Given that a large portion of the private sector activity in the District is linked to the presence of the federal government and other exempt entities, it is unclear whether commercial property would fill the void left if federally owned property were reduced to the hypothetical average level seen in other cities. In fact, a good deal of the commercial property tax base locates in the District due to the federal presence. For example, commercial office buildings in the District are occupied by contractors who provide services to the federal government, lawyers who need to interact with regulatory agencies, and public relations firms that interact with congressional offices, among others. The District of Columbia Tax Revision Commission presented a comparison suggesting that, even with the large concentration of exempt property, the per capita value of the District’s taxable property base is large compared to that of other large cities and comparable to the per capita values in surrounding jurisdictions. 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 make to District revenues and the lack of information on the services they use. Tax-exempt entities do generate revenues for the District, even though they do not pay income or property taxes directly. For example, 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. Fully taxable properties also generate these indirect revenues and a fully taxable property that is similar to a U.S. government property in every respect, except for ownership, would contribute more to the District’s finances than the government-owned property. However, as noted above, it is not clear that the District would have more taxable property than it currently has if the federal presence were reduced to a level typical of other jurisdictions. District officials cite the congressionally imposed height restrictions on buildings as another factor that constrains the District’s property tax base. Although these restrictions may affect the distribution of commercial and residential buildings within the District, it is difficult to determine whether, or to what extent, these restrictions affect the aggregate amount and value of those buildings. Two factors are likely to mitigate the potential negative impact on the District’s tax base. First, the space available for building within the District has not been completely used. At least some of the office or residence space that would have been supplied on higher floors at certain locations, if it were not for the height restrictions, is likely to have been shifted to other locations in the District where building would have been less intensive otherwise. Second, in the face of a given demand for office space, a constraint on the supply of that space will increase its value per square foot. In addition, the restriction could have an effect on the cost of the District’s services by influencing the District’s population density. However, the size of any such effect on service costs is unknown. In addition to the restrictions discussed above, the District is unable to tax the incomes or most purchases of foreign embassies and diplomats, purchases or sales by the federal government, the personal property of the United States or foreign exempt entities, the income of military personnel who are stationed in the District but claim residence in another jurisdiction, or the income of federal government sponsored enterprises (GSE), such as the Federal National Mortgage Association and the Student Loan Marketing Association. All states and localities nationwide are potentially subject to these same restrictions on their taxing authority, even though some of the restrictions may have a disproportionate effect on the District, given the relatively high concentration of these nontaxable entities and persons within its boundaries. In contrast to the case with the income and property taxes, where nontaxable income and property were already excluded from the data we used in our quantitative analysis, the sales data that we used contained some sales to the federal government, embassies, and military personnel that would be exempt. Given data limitations, we were required to make a range of assumptions to estimate the amount of sales that would be exempt (see app. II for details). Our lower estimate for the District’s sales tax revenue capacity placed it below that of 49 of the state fiscal systems; our higher estimate placed it below 31 of the state fiscal systems. The District’s high spending on the key program areas of Medicaid, elementary and secondary education, as well as public safety, particularly police, fire, and emergency medical services, is influenced by several cost factors, including high poverty, economically disadvantaged children and elderly, and high crime. Our quantitative analysis shows that the District’s spending for Medicaid and elementary and secondary education is slightly above what it would take to provide an average level of services, while police spending may be significantly below what it would take to provide an average level of services if provided with average efficiency. However, this analysis does not account for all special circumstances beyond the control of the District, such as high demand for Medicaid, high demand for special education services, and extra police and fire services associated with political demonstrations. In addition, in each of the three key program areas we identified significant management problems, such as inadequate financial management, billing systems and internal controls that result in unnecessary spending, which draw scarce resources away from program services. In recognition of the District’s high-cost environment and management challenges, the federal government provides financial and other support to the District, including an enhanced Medicaid match. Medicaid is a large and growing portion of the District’s budget, with the per capita delivery costs of the program being more than twice the national average. Certain population and delivery characteristics largely outside the District’s control influence these high Medicaid costs. These characteristics include a high poverty rate that contributes to the large numbers of citizens who lack private health insurance and who meet existing Medicaid eligibility criteria, a heavy concentration of Medicaid beneficiaries with chronic health conditions that require expensive and ongoing care, and high real estate and personnel costs for health and long- term care providers. When we adjusted for these high-cost characteristics, our analysis revealed that the District spent only slightly more than that needed to fund the national average levels of coverage and services. However, management problems, which are under the District’s control, have further influenced the local share of Medicaid spending. For example, the District has been foregoing millions in available federal matching funds due to claims management and billing problems, requiring it to use more local funds than necessary in support of the program. If the District adequately addressed these problems and continued to actively pursue reforms already in place, it could receive more federal matching funds and free local funds for other purposes. In recognition of the high costs and management challenges, the federal government provides certain supplemental financial and other support to the District, such as an enhanced federal share of the District’s spending on Medicaid. The District’s per capita costs of providing Medicaid services were more than twice the national average. However, when we adjusted for the District’s high-cost environment, it spent only 11 percent more than what it would take to fund the national average Medicaid coverage and services. Our analysis adjusted for several factors that affect costs but are to a large extent beyond the control of District officials, including people in poverty, the elderly poor, the high cost of living, and real estate and personnel costs for providers. Special population and service delivery characteristics create a high-cost environment in the District, requiring it to spend substantially more than other jurisdictions to fund an average level of Medicaid coverage and services. The District’s high costs for Medicaid are caused by a high demand for Medicaid that, in part, can be attributed to its special population consisting of people at a very high poverty rate and a high proportion of citizens who lack private health insurance because their employers do not offer it or they cannot afford it; thus, a large number of District residents rely on Medicaid for public health care coverage. These factors lead to the District spending disproportionately more to fund an average level of Medicaid coverage and services. Specifically, the District’s poverty level is the second highest among states, and many District residents meet income-based coverage criteria. For example, in 1999 the District had the highest percentage of individuals under age 65 with incomes less than 100 percent of the poverty limit covered by Medicaid (based on 1997 through 1999 data). Overall, one in four District residents receive Medicaid, which was high in comparison to its neighboring state, Maryland. However, when the District’s high poverty rate is taken into account, its Medicaid coverage of low-income residents is about average, as the District has not elected to provide optional coverage or services that are far above the national average. An additional factor influencing costs is that District residents—many of whom rely on Medicaid for health care coverage—have a disproportionately high number of chronic health conditions that require expensive, ongoing care. The District ranks near the bottom in many health indicators relative to other states, a situation that affects the types and levels of services the population needs. For example, among states, it has very high rates of low birth weight infants, adult-diagnosed diabetes, lung cancer, and human immunodeficiency virus (HIV)/acquired immunodeficiency syndrome (AIDS) infection, which tend to be found disproportionately among the poor and in urban areas like the District. Further, these chronic health conditions for the most part are costly to treat, often requiring expensive institutional care or ongoing outpatient treatment, such as drug therapy—all at a time when health care costs, particularly prescription drugs, are increasing. The HIV/AIDS epidemic has presented a particular fiscal challenge for the District’s Medicaid program. For example, the Centers for Disease Control and Prevention reported that the District’s 2001 AIDS prevalence rate was 152 per 100,000 people whereas the next highest state, New York, was 39 per 100,000 people. The costs of treating Medicaid beneficiaries with HIV/AIDS are very high and because the District has the highest infection rate in the country and a disproportionately large number of Medicaid beneficiaries, the fiscal burden of the HIV/AIDS epidemic on the District’s Medicaid program is likely disproportionately larger than most states. Another factor influencing the District’s high Medicaid costs relates to the ways in which health and long-term care services are delivered. Providers generally are located in densely populated urban areas with high real estate and personnel costs, a situation which drives providers’ costs upward. Specifically, many providers have high operating costs in the District, largely due to the high costs of purchasing or renting office space and the necessity of paying higher salaries to medical personnel. Moreover, according to District officials, many of the District’s provider payment rates, particularly for physicians, are below average relative to operating costs. The combined effects of high operating costs and low payment rates may contribute to physicians not accepting beneficiaries of the District Medicaid program. This could be a reason why many of the District’s Medicaid beneficiaries rely on emergency rooms more so than in other jurisdictions. District Medicaid beneficiaries may also not obtain preventive care when needed, thus allowing health conditions to worsen, which could lead to hospital stays. Use of these more costly forms of health care are disproportionately high in the District. One report found the District had the highest emergency room visits per 1,000 of the population in the country as well as the highest hospital admissions rate. Billing and claims management problems are forcing the District to forego millions in federal matching funds and, as a result, requiring it to use more local funds than necessary to pay for expenditures already incurred. Key issues that lead to rejected federal reimbursement claims include incomplete documentation, inadequate computerized billing systems, submission of reimbursement requests past federal deadlines, providing services to individuals not eligible for Medicaid at the time of delivery, and billing for services not allowable under Medicaid. According to a recent report, these problems resulted in the District receiving $40 million less in expected federal reimbursement during fiscal year 2002 than it had projected in its budget. District officials and other experts told us it would be difficult to make any precise estimate of how much the District is foregoing in federal funding. These management problems involve the weaknesses in the processes and systems that several District agencies use to track and process claims for federal Medicaid reimbursement after services have already been provided. The difference between costs submitted for reimbursement and the costs actually reimbursed based on federal criteria result in the use of local, rather than federal money, to pay for these costs. While many states have experienced similar financial management problems, the District’s problems appear to be worse than most states, according to a federal official we interviewed. The magnitude of the problem is serious: Medicaid financial management was identified as a “material weakness” by independent auditors of the District’s fiscal year 2001 financial statements. These problems have been addressed in several of our reports over the years, as well as in reports by the District Inspector General (IG), the District Auditor, and McKinsey and Company. According to these reports, less than projected federal reimbursements have amounted to millions of dollars across the various agencies, creating significant, unexpected pressures on the District’s budget. The management problems rest mostly with individual District agencies that bill for federal Medicaid reimbursement: Child & Family Services Agency (CFSA), Department of Mental Health (DMH), and District of Columbia Public Schools (DCPS). For example, DMH, which was removed from federal receivership in May 2001, did not have an adequate billing process or information management systems in place. District officials told us that DMH’s billing system contained system edits that permitted unallowable costs to go through undetected and then forwarded these claims to the Medical Assistance Administration’s (MAA) fiscal agent for reimbursement, which would reject them after the services were already provided. As a result, Medicaid charges, as well as Medicare, were not properly documented and deemed unreimbursable by the federal government. In fact, officials said the problems were so severe that DMH voluntarily ceased billing for Medicaid federal funds—as well as Medicare—for most of 2001 to resolve these problems and avoid almost certain disallowances from the federal government. DMH did not provide a precise estimate of the federal reimbursement that was lost during this period. The District also does not have an effective centralized monitoring process for Medicaid. Officials of MAA told us they have a limited ability to control and monitor CFSA, DMH, and DCPS—unlike the private third parties that provide services under the regular Medicaid program. Because these public provider agencies are distinct units of the District government, the District’s budget makes it clear that MAA does not have authority over these agencies in terms of financial management, programs, budget, claims for submission or billing, or estimation of federal reimbursement. Officials told us that historically individual agencies, such as DMH or DCPS, made their own Medicaid projections for inclusion in the District’s budget and the projections were almost always highly inflated. Accordingly, the baseline of the District’s budget would indicate a large influx in federal Medicaid funds that would never materialize due to billing and claims management problems. For example, DCPS’s original estimate of expected federal reimbursement for fiscal year 2002 was $43 million, which was later reduced to $15 million by the District chief financial officer (CFO). In fiscal year 2001, the District wrote off over $78 million of several years worth of such unpaid federal claims, which were still in the baseline of its budget. If District agencies adequately addressed these problems, they could receive more federal matching funds and free local funds for other purposes, such as providing an above average level of Medicaid coverage or optional services. While the District has taken some positive steps to improve management, more improvements are needed. District officials have acknowledged the severity of the District’s Medicaid management problems and have taken steps to remedy them. Most significantly, improving management could help the District increase its share of federal Medicaid reimbursement. Most of these reforms have only been implemented within the past year, so it is unclear how effective they will be in the long run. Key examples include the following: The Office of Medicaid Public Provider Operations Reform, which was created in June 2002, has become a needed focal point in the Mayor’s office for integrating billing processes across District agencies and helping these agencies modify their processes and management systems to maximize federal Medicaid reimbursement. The District recently created an $87 million Medicaid reserve to compensate for the costs of Medicaid reimbursements that may need to be covered by local funds and to serve as a cushion for any less than expected reimbursement in federal Medicaid funds, Medicare and Title IV-E. District officials told us they expect to use at least a portion of these funds during the current fiscal year. The District CFO is now responsible for analyzing and clearing any Medicaid projections made by CFSA, DCPS, and DMH (and eventually DHS) before they are incorporated into the District’s budget. Officials told us that the District plans to be more conservative in its projections for federal Medicaid funds to avoid the negative effects of less than expected federal reimbursement. DMH has designed and implemented a new billing process for Medicare and Medicaid, in accordance with the business plan mandated by the court as part of its post-receivership agreement. CFSA is implementing a new computerized billing system, making changes to its data collection process, and working closely with federal Medicaid officials to ensure that any changes meet federal requirements. Recognizing the District’s Medicaid situation, the federal government has provided additional funding, as well as technical assistance and other programmatic flexibilities. Most significantly, in 1997 Congress provided the District with a fixed, enhanced Medicaid federal medical assistance percentage (FMAP) of 70 percent, which has resulted in an influx of millions of additional federal Medicaid funds that the District was not eligible to receive previously. Previously, under the statutory formula that establishes the federal matching share of eligible state Medicaid expenditures, the District received a 50 percent FMAP—the lowest possible under the law. In addition, the District uses programmatic flexibility and technical assistance from the Centers for Medicare & Medicaid Services (CMS), the federal agency within the U.S. Department of Health and Human Services that is responsible for Medicaid. CMS officials told us they have more frequent contact with the District than with many other states. For example, they have reviewed the District’s billing processes and computer systems in some cases to ensure they meet federal criteria. When we adjusted for the District’s service costs and workload factors, our cost analysis suggests that the District spent 18 percent more than what would be necessary to fund an average level of services. However, our analysis was not able to take into account all of the special circumstances facing the District. Specifically, it is likely that significant management problems and disproportionately high special education costs are drawing resources away from elementary and secondary education, suggesting that the District provides less than the national average level of education services. The federal government to some extent has recognized the District’s special circumstances and the extent of its management problems by providing it with special technical and other assistance. We estimate that the District’s elementary and secondary education costs were 18 percent above what it would take to fund an average level of services. Our analysis incorporated several workload factors that represent cost conditions that are largely beyond the control of District officials, which include the number of school age children (excluding those enrolled in private schools), and the specific costs of serving elementary and secondary students and economically disadvantaged children. Our model also took into account the costs of attracting teachers and the maintenance of capital facilities, both of which are higher in the District. When the District’s costs and these workload factors were considered, our analysis showed that the District’s spending is somewhat higher than what it would take to fund a national average level of services. Our analysis, however, probably understated the District’s education costs because we were not able to quantify the District’s significant management problems or high special education costs due, in part, to court mandated services. If these factors could be adequately taken into account, they may show that the District is actually spending less than what is needed to fund a national average level of education services. We, along with the District IG, the District Auditor, and federal inspectors general have identified—and District officials have acknowledged—serious management problems throughout DCPS’s programs and divisions in areas such as financial and program management, as well as compliance with the requirements of federal programs, such as Medicaid and the Individuals with Disabilities Education Act (IDEA). These reports estimate that the local costs of management problems could be in the millions of dollars. However, our cost analysis did not take into account the costs associated with fiscal resources that are wasted due to inefficient management. This limitation likely results in significant amounts of DCPS’s fiscal resources being lost. Many of the management problems at DCPS can be attributed to inadequate financial management, including a lack of effective internal controls and clearly defined and enforced policies and procedures. For example, the independent audit of the District’s financial statements for fiscal year 2001 classified DCPS’s accounting and financial reporting as a “material weakness.” The auditors found that DCPS did not ensure timely loading of budget information into its accounting system, which prevented DCPS from monitoring expenditures and having accurate financial reports. In another instance, DCPS’s procurement procedures were not routinely enforced, as exemplified by capital project purchase orders being processed directly through the DCPS CFO instead of through the procurement office. Recently, DCPS officials acknowledged that they face difficulties in tracking procurement costs, and as a result, individuals at schools may purchase goods without completing a purchase order. Often through a process known as a “friendly lawsuit,” vendors will deliver goods without a purchase order and subsequently notify DCPS of the purchase to receive payment. Last year, DCPS set aside $17 million to compensate for such unauthorized purchases, and spent $10 million of it. DCPS officials provided us with other examples of the limitations of DCPS’s electronic financial management system. These limitations prevent DCPS from adequately tracking personnel costs, which represent approximately 80 percent of the school district’s budget. The system also does not allow DCPS officials to track either the total number of employees or whether particular positions are still available or have been filled. Recently reported problems with managing personnel expenses further highlight DCPS’s financial management problems. In March 2003, DCPS officials announced that the school system had hired about 640 more employees than its budget authorized, resulting in DCPS exceeding its personnel budget by a projected amount of $31.5 million over the entire fiscal year. Also, in December 2002, DCPS officials announced that it paid $5 million for employee insurance benefits and contributed to tax-free retirement accounts for employees who no longer worked for DCPS. Reports have also identified management problems in particular educational programs, which influence costs and negatively affect the quality and level of service provided to students, particularly in special education. For example, a September 2002 investigation by the District Auditor found that DCPS paid $1.2 million to vendors for providing special education services to individuals whose eligibility could not be determined from information on vendors’ invoices. In November 2000, the District IG reported that DCPS paid more than $175,000 in tuition to nonpublic special education schools that failed to meet the standards for special education programs. The District IG also reported inaccuracies in DCPS’s database for special education students, inadequate oversight of special education tuition payments, and insufficient monitoring of nonpublic special education schools. Finally, the District IG concluded that DCPS lacked adequate management controls to ensure that transportation services were adequately procured, documented, and paid. The IG concluded that by implementing certain cost saving measures DCPS could save at least $2.4 million annually. In addition, DCPS has longstanding issues regarding its ability to comply with the laws and regulations of federal education programs, including IDEA, and the U.S. Department of Agriculture’s (USDA) food and nutrition programs. The extent of DCPS’s compliance issues with IDEA have been serious, and by 1998 the U.S. Department of Education (Education) entered into a compliance agreement with DCPS that mandated improvements in DCPS’s special education program. Further, the District has experienced longstanding issues of complying with USDA’s requirements for the National School Lunch Program and the School Breakfast Program. DCPS’s poor management of USDA’s food and nutrition programs resulted in the Mayor and the City Council removing oversight and monitoring responsibilities from DCPS and placing them under a new, independent District State Education Office (SEO). SEO officials told us that while oversight and monitoring have improved, they still face many problems in effectively managing USDA’s food and nutrition programs. Our program review revealed that the District has a high demand for special education and related costs, which are not adequately captured in our quantitative analysis. The District has a disproportionately large share of special education due process hearings that often result in it having to provide more expensive services and pay large legal fees; relies heavily on costly non-public schools; and operates under an array of court orders springing from class action lawsuits, many of which mandate additional types and levels of services. Accordingly, our cost analysis does not sufficiently consider a major education cost driver for the District because we assumed that the District’s special education costs were typical of the average state system, which we found is not the case. For example, the number of special education students has grown rapidly in recent years. Between the 1998- 1999 and 2000-2001 school years, the number of special education students in DCPS grew by over 25 percent, while the total number of nonspecial education students decreased slightly. Over the same period of time, the percentage of special education students attending Boston Public Schools and the San Francisco Unified School District declined about 9 percent and 4 percent respectively. DCPS projects that the number of special education students will continue to grow even as the general student population is expected to continue declining, which will likely cause the special education program to pose an increasingly significant financial burden on DCPS. Overall, the size of the special education population as a percentage of students attending DCPS exceeds the average size for 100 of the largest urban school districts in the United States. Further, evidence suggests that DCPS may also pay a higher cost per special education student than other urban systems. The high costs associated with the District’s large number of due process hearings divert resources from other critical education services. As required by IDEA, a due process hearing gives parents of special needs children the opportunity to present complaints on any matter relating to the education of their children and seek remedies to any shortcomings. Some shortcomings that frequently spur due process hearings in the District include a lack of sufficient educational programs, older school buildings that are not handicapped accessible, failure to meet deadlines for providing services in accordance with students’ individualized education plans (IEP), and not sufficiently involving parents in the development of IEPs. The number of due process hearings held in the District in 2000 exceeded every state except New York, and DCPS estimates that the number of hearings requested will continue to grow as these shortcomings continue. DCPS officials also acknowledged that their special education program suffers from a range of shortcomings, such as a lack of early intervention and prevention and underinvestment in program capacity. For example, DCPS officials noted that many special education teachers are not certified to provide special education. According to some officials, due process hearings in the District often become forums for parents to advocate moving their child out of public schooling and into a private facility—at the District’s expense. Due process hearings may result in the placement of a child in a much more costly setting, such as the transfer of the student from a public to an out-of- District private facility at the expense of DCPS, or mandating additional types or levels of services. Furthermore, the due process hearings result in legal costs to the District because the parents of a student often use a law firm to handle their cases, and if the student prevails in the hearing, the District must pay the legal fees. DCPS officials and other key observers have told us that many parents in the District want their children to be moved into private facilities and lawyers respond to parents wishes and DCPS’s deficiencies, thereby realizing financial gains. For example, DCPS staff informed us that one law firm alone represented students in over 900 due process cases between September 2002 and January 2003 and earned approximately $1 million in fees from the District in 1 year. Even though Congress implemented a cap on legal fees related to special education, District officials told us the cap does not appear to have affected the incidence of due process hearings, but we did not independently verify these claims. DCPS officials indicated that DCPS has also incurred additional costs to comply with court orders and settlements resulting from class action lawsuits. For example, DCPS officials said that the costs of transporting special education students doubled after implementing service improvements as required by the court in the Petties case. However, DCPS could not verify that some of the costs attributed to the Petties case were court ordered. DCPS officials stated that even with increased spending and greater services, they do not think they will be able to meet all of the court ordered service improvements. According to DCPS officials, another significant case was the Nelson case, which required DCPS to develop emergency evacuation plans for students with mobility impairments. DCPS officials said that complying with the court order required DCPS to make significant capital expenditures. DCPS also reported that it has a high percentage of special education students attending nonpublic special education schools because it lacks the staff and facilities to adequately serve its special education students. DCPS officials acknowledged that the school system historically has relied on contracting with non-public education facilities, and DCPS has never built up the capacity to deliver sufficient special education services within DCPS. Services provided in non-public special facilities services are much more costly to DCPS than services provided in public institutions, as non- public schools charge much more for their services. For example, a special education student attending a nonpublic institution costs about twice as much as one receiving special education within DCPS. Spending on these services draws resources away from other public education services, as well as helping to build up the capacity to deliver more special education services within DCPS. In recognition of the District’s special circumstances and management problems, the federal government, to some extent, has provided technical assistance to the District. Specifically, Education has provided substantial assistance to DCPS, including, since 1996, a dedicated liaison to DCPS to help identify opportunities for providing technical assistance. According to an Education official, no other school district in the country has such a departmentwide liaison. In addition, Education officials told us they have provided extensive technical assistance to DCPS, including guidance for developing an education plan, as well as help in improving its special education program, establishing performance standards for students, and developing a new database to track student data to increase DCPS’s capacity to comply with the future data requirements of the No Child Left Behind Act. Education staff has also hosted conferences to help the DCPS leadership better understand their oversight responsibilities for federal funding programs. The District’s costs for the key public safety functions of police and fire protection were far above average, according to our analysis. In fact, the District’s costs were higher for police than any other category. However, our analysis showed that when we adjusted for the District’s high-cost environment, the District spent far less on both police and fire than it would take to fund a national average level of services in these areas. However, the factors considered for both police and fire do not adequately capture the demands the District faces. Most significantly, our factors do not include any measures of the various public safety demands and costs associated with the federal presence and the District’s status as the nation’s capital, such as extra protection for federal officials, including the President and Vice President, as well as diplomatic personnel and foreign dignitaries who visit the city; nor did they capture the police and fire costs associated with the multitude of regular special events and political demonstrations that often draw thousands of people. As a result, the District’s spending on traditional public safety services for residents, such as policing neighborhoods, traffic control, and fire and emergency medical services, is likely even further below average than our analysis would suggest—indicating the District is providing fewer traditional police and fire services to its citizens. In addition, the District’s current cost tracking processes do not adequately capture the true total costs associated with providing police and fire services to support the federal presence, putting the District at a disadvantage in recovering more costs related to protection, special events, or demonstrations. Finally, while the District has received some special federal funding in recognition of the services it provides to support the federal presence, it is unlikely this funding fully compensates for all related costs—indicating that local dollars are being used in support of federal activities. According to our analysis, the District’s costs of providing police services were very high—at four and one-half times the national average—as were the costs of providing fire protection services, which were nearly double the national average. However, our analysis indicated that when we adjusted for the District’s high-cost environment for both police and fire, it was spending below what it would take to fund an average basket of services typically associated with police and fire departments. Specifically, the District’s spending on police was 66 percent below what would be necessary to fund a national average level of services based on the urban basket of services and 40 percent below using the state basket of services. Furthermore, fire protection was 28 percent below using the urban basket of services. Our analysis for police was based on three factors only—murder rates, the 18-24 year old population, and the general population. The District’s murder rate, which served as an indicator of the prevalence of violent behavior, was extremely high at more than seven times the national average. Further, we found that the percentage of residents in the 18-24 age range—a group prone to commit more crimes than any other age group— was disproportionately large in the District. Similarly, our workload factors for fire protection—multifamily housing units and older housing units built prior to 1939—indicated that the District faced high costs related to providing fire protection services. Specifically, the District had disproportionately high instances of older housing units, which are more prone to fires, and disproportionately high numbers of dense living conditions in multifamily units, another indication of the extent of fire services a jurisdiction must provide. The workload factors for police and fire protection suggested that the District’s costs of providing typical services in these areas were disproportionately higher than in most other jurisdictions. For several reasons, our analysis may understate what the District spends on police and fire services for residents. First, our factors may not fully capture the extent of police and fire demands or related costs in the District. Specifically, a great deal of uncertainty exists as to whether or not some of our factors adequately measure demand for services or cost burdens. In addition, we believe these factors understated the District’s expenditure demands because they did not capture any costs related to services provided to the federal government. For example, the factors do not adequately reflect increases in the District’s daily population due to tourists, college students and other commuters, as well as services related to the federal presence for which it does not receive full reimbursement, such as protection for federal officials and dignitaries, special events, or demonstrations. Because these costs were not taken into account in our analysis, we believe the District is likely providing less police or fire protection services to residents. As the nation’s capital, the District is continually faced with paying for expenses to support the federal government's presence, such as extra services for federal officials, including the President and Vice President, and diplomatic personnel and foreign dignitaries who visit the city. It is also responsible for paying for services related to an array of special events and political demonstrations that often draw thousands of people, sometimes with short notice. The federal government routinely provides the District with special funding and other forms of assistance; however, it is unlikely that the federal government fully compensates the District for all expenses associated with the federal presence, meaning many related services provided by the District are funded with local money. Although the 1973 Home Rule Act requires the District, including the Metropolitan Police Department (MPD), to support federal agencies in providing protection to the President and Vice President as well as foreign missions and embassies, the federal government does not routinely reimburse the District for these expenditures, which District officials say places a financial strain on their budget and could negatively affect the operations of public safety agencies. The District’s Fire and Emergency Medical Services (FEMS) department also provides similar support to the federal government. Although the police and fire departments typically receive advanced notification of federal protection needs from the U.S. Secret Service, they are sometimes notified the day of or hours prior to an event, resulting in additional costs by necessitating the shifting of employees, calling up employees to back-fill positions, and paying overtime to employees. It also makes it difficult to plan or budget for federally related expenses. For example, MPD reported to us that in fiscal year 2002 it incurred 3,240 hours in police officer overtime hours related to providing protection to federal officials and dignitaries, at a cost of over $101,000. MPD operates a special dignitary protection unit that is solely responsible for assisting federal law enforcement agencies, such as the Secret Service, by providing police escort and protection for federal officials, such as the President and Vice President, as well as key foreign dignitaries. For example, when the motorcade of a federal official, such as the President or a key dignitary, travels anywhere in the District, MPD is responsible for closing off streets, sending out scout cars in advance of the motorcade, and placing motorcycles beside and in front of the official cars; for the President, as many as 100 traffic posts are sometimes needed. MPD officials noted that they have no choice but to provide these services because the District controls its streets, so MPD must assist the federal agencies in providing protective services for motorcades that travel upon them, as would be the case in whatever jurisdiction these officials visited. Often the magnitude of the required duties exceed the capacity of the dedicated unit; as a result, other MPD officers must be pulled from their regular duties, including policing District neighborhoods. According to MPD, the key difference between the District and other jurisdictions is the extent of the protective duties. For example, District officials told us the President often leaves the White House several times a day, necessitating police and fire support, whereas he visits other jurisdictions, such as San Francisco, with much less frequency. Similarly, FEMS regularly uses its resources to provide services to federal officials and dignitaries. For example, officials told us that a District emergency medical technician (EMT) unit is required to accompany the President whenever or wherever he travels within a 50-mile radius of the White House, as well as to the presidential retreat, Camp David, in Maryland. Further, FEMS is required to pre-inspect any District buildings where the President, Vice President, or a key dignitary is scheduled to appear. District officials told us that special events and demonstrations also result in the District incurring costs funded with local dollars. Special events also affect police operations by diverting police officers from their normal duties as well as incurring costly overtime payments to police officers who are called upon during their scheduled time off. In addition, MPD staff said that it often does not have enough officers in its special events unit to provide all the necessary security for large events, meaning it must call up officers on leave or contract with officers from other jurisdictions. As the nation’s capital, the District is an attractive and preferred venue for demonstrations, protest rallies, and other special events as it provides a “high profile” venue and potential for media coverage for individuals and organizations seeking a mechanism for national publicity and potential access to legislators and other government officials. Thus, the District frequently hosts numerous planned and unplanned special events that often are not fully reimbursed by event organizers or the federal government. Although the District receives positive economic benefits generated by an influx of visiting demonstrators or protestors and dignitaries, such as revenue from sales taxes in restaurants, hotels, and stores, the District must also bear a financial burden in providing unbudgeted public safety services related to these events. A comparison of the District to our case study sites of San Francisco and Boston suggested that the magnitude of the District’s expenses related to protection, special events, and demonstrations is disproportionately higher than those of San Francisco and Boston police departments, which are both major international cities. For example, we collected data on overtime hours from several recurring special events in the District, Boston, and San Francisco and found that the District’s expenditures were roughly four to six times greater than those other cities. According to MPD officials, expenditures for the demonstrations resulting from the International Monetary Fund (IMF)/World Bank conferences represent the largest unreimbursed expenditures. A IMF/World Bank conference—and resulting demonstrations—is scheduled to occur at those organizations’ headquarters in the District twice in a fiscal year, usually during the spring and fall. District officials noted that the conference occurs in the District only because it is home to IMF and World Bank offices. MPD reported incurring over 116,800 in police officer overtime hours at a cost of more than $5.7 million during the fall of 2002, and this figure did not include the costs of purchasing new equipment, such as security fencing, or wear and tear on existing equipment and automobiles. MPD officials told us they also had to contract for officers from other jurisdictions to provide added security. MPD officials told us they estimated that the total costs of IMF/World Bank conferences could be as high as $14.8 million, but did not provide documentation for this figure. The national Independence Day celebration on the National Mall serves as a key example of a large scale, federally related special event that results in significant employee overtime expenses to the District. MPD officials told us that the U.S. Park Police (USPP)—which has jurisdiction over the National Mall, where the event is held—could not handle an event of this magnitude on its own. Because the National Mall is within the District’s boundaries, it must assist in security and assume any costs. On July 4, 2002, MPD activated 1,500 officers to work overtime to supplement USPP, and MPD brought in officers from other jurisdictions as well. MPD paid officers from other jurisdictions for their services, but MPD officials told us the department received no reimbursement from the federal government. FEMS officials also provided extensive services during the Independence Day celebrations, including emergency medical technicians. A final example of the federal presence’s impact on the District involves MPD’s newly constructed state-of-the-art command center that is intended to coordinate the law enforcement aspects of special events or emergencies, such as the IMF/World Bank conference. MPD officials told us that their previous facilities were not sufficient to effectively manage such events, so they felt it necessary to construct a new one at a total cost of nearly $7 million—all out of the District’s capital budget. The federal government has not provided financial support for constructing or maintaining the command center, but federal law enforcement agencies (e.g., the U.S. Secret Service, Federal Bureau of Investigation, the U.S. Capitol Police, and the USPP) nonetheless rely on the facility to coordinate and manage law enforcement responses to emergencies or large-scale special events within District boundaries. However, in the past the federal government has provided some funding to MPD for other capital improvements to MPD facilities. District public safety officials told us that in recent years the number of special events and demonstrations, along with the potential for violence and security threats during them, have increased as have the security needs of federal officials and key dignitaries. Accordingly, District officials told us that unanticipated and unreimbursed expenditures have escalated. In addition, District officials told us that after the September 11, 2001, terrorist attacks—and the resulting national focus on enhanced homeland security preparedness and increased threats of additional terrorist attacks—their ongoing costs have escalated even more. Police and fire officials told us that since September 11 they have provided permanently higher levels of security and additional services to the federal government. The events of September 11 have also affected the security needs of special events and demonstrations, leading to increased costs to the District. For example, officials told us that, in 2002, expenses to ensure security were even higher for national Independence Day celebrations than in past years because of concerns about terrorist attacks on the National Mall. However, specific data are not available for this event and others. The District’s current cost tracking processes do not provide officials in MPD or FEMS, or the District CFO, with reliable financial information to allow them to better estimate and budget for federally related expenditures, control overtime costs, or strengthen their cases for reimbursement from the federal government. In particular, the District is not collecting data and tracking all expenditures to determine its true total costs associated with its public safety programs and activities, putting the District at a disadvantage in capturing and recovering more costs related to protection, special events, or demonstrations. MPD and FEMS do some tracking of personnel costs associated with large events, such as the IMF/World Bank conference as well as ongoing protection, but neither agency routinely tracks data regarding supplies, equipment, training, vehicle maintenance, and repair costs, and they are likely underestimating the full extent of expenditures related to federal protection, special events, and demonstrations. The absence of a rigorous cost tracking process in MPD and FEMS appears to have hindered their ability to determine the true costs of providing public safety and other services in support of the federal presence. For example, MPD data on special events related to overtime paid for federal holiday activities, such as Independence Day, are aggregated with all other holiday overtime. The quality, accuracy and completeness of these data are also lacking. Recently, MPD and FEMS have attempted to improve tracking of costs associated with special events in response to direction from the District CFO’s Budget Office. For example, MPD reported that it now tracks special event overtime hours and associated costs by the respective police unit, and the District CFO’s Budget Office recently established a separate account to track actual expenditures for these events. Although it is unlikely that the federal government fully compensates the District for all related expenses, the federal government has provided the District with special funding and other forms of assistance in recognition of the magnitude of public safety demands related to the federal presence. For example, the District recently received $16 million to compensate for any expenses related to the demonstrations resulting from the IMF/World Bank conferences. However, District officials told us this level of funding would not be sufficient to cover many costs incurred by District agencies. Specifically, District officials claimed that each IMF/World Bank event might result in total costs, including personnel and equipment, of as much as $15 million, and two events are scheduled to occur within a fiscal year— although the District was unable to provide documentation for this figure. The District received an additional $15 million in fiscal year 2003 for emergency planning and security enhancements. Further, in April 2003 as part of its urban security initiative, the Department of Homeland Security (DHS) awarded the District an additional $18 million; DHS also awarded funding to other major cities. Another key example was Congress providing over $200 million to the District as part of the Defense Appropriations Act for fiscal year 2002 to improve emergency preparedness and the capacity of the District to deal with any terrorist attacks. This funding, which went to a number of District agencies including MPD and FEMS, as well as non- District entities, was intended to assist in purchasing equipment to respond to chemical or biological weapons, improve its public safety communications systems, improve emergency traffic management, and enhance training, among other things. When forced to balance the budget when a structural imbalance exists, governments often choose to hold down debt by deferring capital improvements. The District has thus deferred infrastructure maintenance and new capital projects because of constraints within its operating budget. Contributing to the District’s difficulties is its legacy of an aging and deteriorated infrastructure, particularly in the schools, and maintaining its 40 percent share of the funding for the area’s metropolitan transit system. The District’s Chief Financial Officer (CFO) is actively managing the District’s debt, refinancing some bonds to reduce interest and issuing bonds backed by funds from the tobacco settlement. Nevertheless, the District cannot take on additional debt without cutting an already low level of services or raising taxes that are already higher than other jurisdictions, and so it has chosen to put off needed repairs to streets and schools and postpone new construction that would improve the city’s infrastructure. In fact, our analysis shows that the District’s debt per capita ranks the highest when compared to combined state and local debt across the 50 states. The District operates with an aged and badly deteriorated infrastructure— antiquated school buildings, health facilities, and police stations; out-of- date and inadequate computer systems; and aging sewer systems—for which the District has been unable to fund the needed improvements. The District is, however, attempting to address its backlog of infrastructure needs which, as several studies have noted, was long ignored throughout the 1970s, 1980s, and early 1990s. This legacy continues to exacerbate the current situation. The District’s level of spending for infrastructure repairs and improvements has increased steadily since 1995 and 1996, when virtually all major projects were deferred. The reality is, however, that the District continues to defer major infrastructure repair and development and capital acquisitions due to its budget and debt issues, while the legacy from its history of neglected infrastructure needs continues. Our approach to analyzing the District’s infrastructure projects differed from the approaches used to address the other objectives in this report. Because of the variety of ways infrastructure projects are owned, managed, and reported by other jurisdictions, comparative information on infrastructure across states and local jurisdictions was not readily available; therefore, we did not do a comparative analysis of the District’s infrastructure with states or other jurisdictions. We reviewed the data that the District has available in its annual budget, financial plans, comprehensive annual financial reports, and other documents. The District is deferring significant amounts of capital projects by not funding or taking action on specific repairs and improvements to the District’s infrastructure. For the 6-year period fiscal years 2003 through 2008, the total number of projects that were not approved for funding was 115. These 115 projects represent about 43 percent of the total identified capital cost needs for fiscal years 2003 through 2008. Many of these capital projects affect the safety and health of citizens. Deferred public safety projects include, for example, renovation of the third and sixth police district buildings and a disaster vehicle facility. District of Columbia Public Schools’ (DCPS) fiscal year 2003 deferred projects included the replacement of electrical systems and heating and cooling plants and the upgrade of fire alarms, intercoms, and master clocks. Public health deferred projects include asbestos abatement and lighting system retrofitting in local facilities. Deferred transportation projects included rehabilitating bridges, paving alleys and sidewalks, and resurfacing streets. Deferred maintenance project costs for three agencies total 79 percent of the total percentage of all deferred maintenance projects for fiscal year 2003—DCPS totals about 34 percent, Department of Transportation is about 30 percent, and the Metropolitan Police Department is about 15 percent. Table 7 lists the agencies and their deferred maintenance project costs for fiscal year 2003 and the 6-year period fiscal years 2003 through 2008. See appendix IV for a detailed list of agency projects and funding requests that the District has deferred. The District’s Capital Improvement Plan (CIP) funding for fiscal years 2003 through 2008 is currently budgeted at $3.3 billion for a total of 229 projects. For fiscal year 2003, the amount for planned funding and expenditures is $881 million for projects such as school modernization, street repairs, roadway reconstruction, Metro bus replacement, equipment acquisition or leases, fire apparatus, and emergency communication systems. See table 8 for an overview of the District’s planned funding and expenditures for fiscal year 2003 and the period fiscal year 2003 through fiscal year 2008. These amounts do not include $371 million in deferred maintenance project costs from table 7, as well as an additional $51 million in other deferred project costs that were not approved in fiscal year 2003 due to budget concerns. In addition, the District estimates that the total amount of deferred projects not included in the plan for fiscal years 2003 through 2008 total approximately $2.5 billion. In many instances, new project requests require more financing than the District could afford to repay in future years. As shown in table 9, a total of 115 capital projects with a cost of about $422 million were deferred in fiscal year 2003. District officials told us that, in an attempt to remain steadfast to spending affordability limits, they did not recommend these projects for funding even though some projects ranked high in priority in the CIP process. Of the $422 million in deferred projects for fiscal year 2003, $371 million was deferred maintenance, and the remaining $51 million represented other deferred projects. These projects will eventually need to be funded, but possibly at a higher cost later. Table 9 shows the approximate amount of funding that would be required if all requested infrastructure projects had been approved for fiscal year 2003 and fiscal years 2003 through 2008. The category “other deferred infrastructure and acquisition projects” included 35 projects, at a total cost of about $51 million for fiscal year 2003 and about $345 million over the 6-year period fiscal years 2003 though 2008. Similar to the financial situation of deferred maintenance, these projects were not approved because the projects required more financing than the District could afford to repay in future years. (See table 10.) There has been little change in the District’s outstanding general obligation debt, which totaled $2.67 billion as of September 30, 2002, except for a drop in 2001 attributable to the issuance of bonds backed by funds received from a multistate settlement with tobacco companies. Debt per capita has also remained fairly constant except for a dip as tobacco bonds were issued. In contrast, with expenditures holding steady, debt service costs as a percentage of expenditures have increased. As a percentage of local general fund revenues, debt service costs, which were 7.3 percent of revenue for fiscal year 2002, are expected to climb to approximately 10 percent by 2006. The District’s annual debt service for the fiscal year ended September 30, 2002, was $272 million, or approximately 7.3 percent of the local portion of general fund revenues, and the District’s projected debt service for fiscal year 2003 is about $304 million, which represents 8.3 percent of the local portion of projected general fund revenues. Although this level of debt service is well within the statutory limit of 17 percent of general fund revenues, the effect of issuing substantially more debt without a corresponding increase in general fund revenue or cuts in other areas of the budget would adversely affect the District’s debt ratios, its future ability to service its debt, and, consequently, its credit rating. The primary funding source for capital projects is through the issuance of tax-exempt bonds. These bonds are issued as general obligations of the District and are backed by the full faith and credit of the District. Several sources of funding for infrastructure and capital projects are presented in the capital budgets for fiscal years 2003 through 2008. However, only general obligation bonds and master equipment lease funding sources have an impact on the annual operating budget. These funding sources require debt service payments, which include principal and interest and are paid from general fund revenues. General obligation bonds represent about 52 percent of the funding sources for the District’s capital plan for fiscal years 2003 through 2008. (See table 11.) Faced with decreasing revenues and a significant backlog of unfunded capital projects, the District is taking steps to reduce debt service costs. In February 2003, the District’s CFO testified that in the first quarter of fiscal year 2003, the District issued general obligation bonds to finance capital projects through a complex transaction that produced historically low interest rates, and refinanced (refunded) outstanding general obligation bonds and certificates of participation, at lower interest rates. According to the Deputy CFO, Office of Finance and Treasury (OFT), the District took advantage of market conditions in October 2002 and used an interest-swap mechanism, resulting in an average interest rate of approximately 4 percent on a portion of the bonds. Another portion of the bonds was issued as variable-rate demand bonds, and the Deputy CFO reported that this allowed the District to benefit from extremely low interest rates (about 1.25 percent currently). The Deputy CFO also stated that OFT has continued to focus on issuing its bonds based on actual capital spending needs (as opposed to its previous approach of planned spending levels), reducing the amount of unspent bond proceeds on hand, and thereby reducing debt service expenses. District officials testified that these actions produced substantial debt service savings totaling about $20 million. There was little change in the District’s total outstanding general obligation debt for the period 1995 through 2000, as shown in figure 5. The drop in outstanding debt in 2001 was attributable to the issuance of tobacco settlement bonds with the funds used to defease approximately $482.5 million of the District’s outstanding general obligation bonds. As of September 30, 2002, the District’s outstanding general obligation bonds totaled $2.67 billion. (See fig. 5.) Since fiscal year 1991, the District’s outstanding general obligation bonds have included balances related to the $331 million in deficit reduction bonds that were issued by the District in 1991 to eliminate the operating deficit in its general fund that year. As a result, the District’s debt included amounts that were used to cover operating expenditures. The District has continued paying debt service on those bonds in the intervening years. In fiscal year 2002, $38.9 million of the District’s $272.2 million in debt service expenditures was to cover principal and interest paymets on the deficit reduction bonds that had been issued in 1991. The District anticipates that it will make the final payment on these bonds in fiscal year 2003, in the amount of $39.3 million. Debt per capita measures the level of debt burden placed on each citizen of a state or city. Since the citizens are ultimately responsible for financing the debt through payment of taxes, debt per capita is a good way to measure changes in a city’s debt load or compare a city’s debt load to that of another municipality. The District’s ratio of general obligation debt per capita was fairly constant from fiscal years 1995 through 1999. (See fig. 6.) The general obligation debt per capita further declined in 2001 because of the reduction in outstanding general obligation debt through the issuance of tobacco settlement bonds. District officials offered the following explanations for the current situation of high debt per capita even while there has been a trend of significant deferred capital needs: (1) high funding for education and the Washington Metropolitan Area Transit Authority (WMATA), (2) funding projects with lifetimes shorter than the terms of the bonds, (3) funding enterprise fund activities, and (4) funding services that are now being provided by the federal government. The District’s largest authorization items over the past 18 years have been public schools (16.8 percent of total funding) and WMATA funding (12.0 percent of total funding). District officials also explained that the District had funded projects with lifetimes shorter than the term of the bonds issued, as well as provided funding for the original convention center, WASA, the Washington Aqueduct, and public assisted housing. These activities are now operating outside the District’s general fund. In addition, District officials identified past major events and circumstances that contributed to the present levels of long- term debt and deferred infrastructure projects, including the issuance of bonds in large amounts in fiscal years 1990, 1992, and 2002 for major authorization items such as public assisted housing and public education. From 1995 through 1998, the District’s debt service costs as a percentage of total general fund expenditures increased slowly, as shown in figure 7. Most of the increase was attributable to a steady increase in outstanding debt, while expenditures remained somewhat steady. However, from 1999 through 2001, the District’s debt service as a percentage of expenditures decreased substantially, due primarily to the defeasement of approximately $482.5 million in general obligation bonds through the issuance of tobacco settlement bonds. This trend was a result of a unique, one-time, permanent reduction in the District’s outstanding general obligation debt. The most recent calculations show that, for 2002, the District’s debt service costs amounted to about 7.3 percent of general fund revenues, as shown in figure 8. Based on the District’s projections, the percentage of debt service costs to the local portion of general fund revenues is expected to climb steadily to approximately 10 percent by 2006. The District’s projections assume that debt service costs will increase at a higher rate than local revenues. Like debt costs as a percentage of expenditures, the District’s debt service expenditures as a percentage of revenue remained level through 1999, then decreased substantially in 2000 and 2001 (see figure 8). The decrease was due to the issuance of the tobacco settlement bonds mentioned in the debt service costs to general fund expenditures discussion, as well as an increase in general fund revenues over that same period. During fiscal year 1995, the District’s general obligation debt was downgraded by all three rating agencies to “below-investment-grade” or “junk bond” levels. Since 1998, with the District’s financial recovery, each rating agency has issued a series of upgrades to the District’s bond rating. The upgrades that occurred in 1999 raised the District’s ratings back to “investment grade” levels. The upgrades in the bond ratings by the rating agencies made the District’s bonds more marketable, resulting in a lower cost of capital to the District. The District continues to have the goal of having its credit rating raised to the “A” level. In October 2002, the bond rating agency, Fitch IBCA, Inc., reviewed its rating for the District and reported that although the BBB+ long-term general obligation bond rating reflects the sound financial cushion that the District has built up over the last several years and the District’s demonstrated ability to respond quickly and effectively to funding shortfalls and unexpected expenditure needs while still strengthening reserves, its debt levels remain high and capital needs are substantial. While the District has seen significant improvement in its credit ratings over the last couple of years, its Baa1 from Moody’s rating places the District in the lowest tier among 35 U.S. cities. (See fig. 9.) Our analysis shows that the District’s debt per capita ranks the highest when compared to combined state and local debt across the 50 states. The District funds many infrastructure projects that in other U.S. cities would be financed either in part or in whole by state governments. For this reason, we have analyzed U.S. Census Bureau (Census) data that combine debt issued by the state government and all local governments within that state. The resulting debt per capita figure shows a complete picture of the debt burden for a state and all cities and municipalities within the state. From the Census data, we analyzed the portion of long-term debt that is backed by the full faith and credit of the government entity issuing the debt. This portion of long-term debt is supported solely by the taxing authority of the entity issuing the debt. Based on the Census data from all 50 states and the District of Columbia, the District shows the highest debt per capita level at $6,501. It is important to note that the Census data figures for the District’s “full-faith and credit debt outstanding” as of April 2000 is significantly higher than the District’s audited balance of general obligation debt as of September 30, 2000. Therefore, we also included an “adjusted” level of debt to reflect the lower, audited general obligation debt level. Even using the audited lower level of debt, the District still ranked highest in debt per capita when compared to the 50 states. Based on the Census data, debt per capita in the other states ranges from a low of $173 (Oklahoma) to the second highest debt per capita of $4,348 (for both Hawaii and Connecticut). The median debt per capita is $1,462. The average debt per capita is $1,812. (See table 12.) We also compared the District’s outstanding debt burden to that of the 50 state fiscal systems in terms of debt as a percentage of own-source revenue capacity for fiscal year 2000, using our own range of estimates of that capacity. Our results show that the District’s debt is larger relative to the resources it has available to repay it than that of any state fiscal system. (See the last two columns of table 12.) We estimated that the District’s outstanding debt was equal to between 114 percent and 129 percent of the District’s own-source revenue capacity in fiscal year 2000. Both of these percentages were higher than those of any state fiscal system and well above the state median of 38 percent.

Summary: District officials have recently reported both a budget gap and a more permanent structural imbalance between costs and revenue raising capacity. They maintain that the structural imbalance largely stems from the federal government's presence and restrictions on the District's tax base. Accordingly, at various times District officials have asked the Congress for additional funds and other measures to enhance revenues. In a preliminary September 2002 report, GAO concluded that the District had not provided sufficient data and analysis to discern whether, or to what extent, it is facing a structural imbalance. At that time, GAO also agreed to perform a more comprehensive analysis and was asked to (1) determine whether, or to what extent, the District faces a structural imbalance between its revenue capacity and its public service responsibilities, (2) identify any significant constraints on the District's revenue capacity, (3) discuss factors beyond the control of District officials that influence the District's spending in key program areas as well as factors within its control, such as management problems, and (4) report on the District's deferred infrastructure projects and outstanding debt service and related expenses that might be affected by a structural imbalance. The District concurred with our key findings. GAO used a multifaceted approach to measure structural imbalance that GAO defines as a fiscal system's inability to fund an average level of public services with revenues that it could raise with an average level of taxation, plus the federal aid it receives. This approach compared the District's circumstances to a benchmark based on the average spending and tax policies of the 50 state fiscal systems (each state and its local governments). However, the benchmark is adjusted by taking into account circumstances that are beyond the control of state and local government officials (e.g., number of school-age children and value of tax bases). GAO supplemented this analysis with reviews of the District's key programs to provide insights on factors influencing spending, and reviewed deferred infrastructure and outstanding debt. The cost of delivering an average level of services per capita in the District far exceeds that of the average state fiscal system due to factors such as high poverty, crime, and a high cost of living. The District's per capita total revenue capacity is higher than all state fiscal systems but not to the same extent that its costs are higher. In addition, its revenue capacity would be larger without constraints on its taxing authority, such as its inability to tax federal property or the income of nonresidents. The District faces a substantial structural deficit in that the cost of providing an average level of public services exceeds the amount of revenue it could raise by applying average tax rates. Data limitations and uncertainties surrounding key assumptions in our analysis made it difficult to determine the exact size of the District's structural deficit, though it likely exceeds $470 million annually. Consequently, even though the District's tax burden is among the highest in the nation, the resulting revenues plus federal grants are only sufficient to fund an average level of public services, if those services were delivered with average efficiency. The District's significant management problems in key programs waste resources and make it difficult to provide even an average level of services. Examples include inadequate financial management, billing systems, and internal controls, resulting in tens of millions of dollars being wasted, and hindering its ability to receive federal funding. Addressing management problems would not offset the District's underlying structural imbalance because this imbalance is determined by factors beyond the District's direct control. However, addressing these management problems would help offset its current budget gap or increase service levels. The District continues to defer major infrastructure projects and capital investment because of its structural imbalance and its high debt level. These two factors make it difficult for the District to raise taxes, cut services, or assume additional debt. Although difficult, District officials could address a budget gap by taking actions such as cutting spending, raising taxes, and improving management efficiencies. In contrast, a structural imbalance is largely beyond District officials' direct control. If this imbalance is to be addressed, in the near term, it may be necessary to change federal policies to expand the District's tax base or to provide additional financial support. However, given the existence of structural imbalances in other jurisdictions and the District's significant management problems, federal policymakers face difficult choices regarding what changes, if any, they should make in their financial relationship with the District.