The federal government supplies subsidies to PHAs to help make up the difference between what low-income tenants pay in rent and the cost of operating low-rent public housing. The formula for providing these operating funds changed in January 2007. Under the formula change, some PHAs were eligible to receive an increase in federal operating funds compared to the previous formula, and others qualified for a decrease. Both the increases and the decreases are phased in; PHAs facing decreases had an opportunity to limit their formula eligibility losses through the adoption of management changes. However, the amount that a PHA qualifies for under the new operating fund formula (whether it is an increase or a decrease) is reduced if Congress appropriates less money than is necessary to fund all agencies at 100% of their eligibility (as Congress has done in most recent years). This report is designed to provide a brief overview of the changes to the public housing operating fund formula that began in January 2007. Public housing costs are divided into two main categories: capital costs and operating costs. Capital costs are the costs of major renovations or modernizations. Operating costs are the day-to-day costs of running a building, such as utility, administrative, and routine maintenance costs. Operating costs vary based on many factors, including the age of a building, its heating and cooling systems, and its location. In the early years of the public housing program, PHAs were expected to meet their operating costs through the rents they collected. Over time, tenant rents were no longer sufficient to cover public housing operating expenses, in part because tenants became poorer and therefore unable to pay as much in rent, and in part because the costs of maintaining the buildings increased as they aged. In the late 1960s, Congress began providing operating subsidies to PHAs to supplement the low rents paid by tenants. The system in place for providing those subsidies until 2001 was the Performance Funding System (PFS). In a 1998 public housing reform law, Congress responded to criticisms that the PFS formula was outdated by creating a new Public Housing Operating Fund. The law required the Department of Housing and Urban Development (HUD) to use negotiated rulemaking to develop a new formula for distributing the funds. A negotiated rulemaking committee convened in 1999 involved PHAs and other stakeholder groups. During deliberation, it was agreed that sufficient data were not available to determine the true costs of operating public housing and that a study should be undertaken. Until the results of the study were available, the committee agreed to use a modified version of the PFS to create an interim operating fund formula. This interim formula took effect in 2001. HUD contracted with the Harvard Graduate School of Design to conduct the public housing operating cost study; its results were published in 2003. Another negotiated rulemaking committee was established to use the results of the study to develop a final formula to replace the interim formula. HUD published a proposed rule in the spring of 2005, but the rule was criticized for differing significantly from the agreements made during negotiated rulemaking. HUD published a final rule in the fall of 2005 that more closely resembled the initial agreement of the negotiated rulemaking committee. The new formula took effect in January 2007. PHAs, which are funded on a calendar year basis, began receiving funding under the new formula in CY2007. The operating fund provides subsidies to PHAs to make up the difference between what it costs to run public housing and what low-income tenants pay in rent. Under the interim formula, the calculation for determining a PHA's operating subsidy eligibility used two components: formula expenses (meant to represent the cost of running public housing) and formula income (meant to represent the amount collected in tenant rents). HUD subtracts a PHA's formula income from its formula expenses and the amount by which the income is short of the expenses is the PHA's operating subsidy eligibility. The new operating fund formula uses the same principle, but a more complex equation with changes to the way certain components are calculated. Formula expenses are the sum of three categories of estimated expenses: non-utility expenses, utility expenses, and other add-ons. Non-utility expense levels are per unit estimates of the basic non-utility operating costs of maintaining public housing. Under the old formula, the non-utility expense levels set for a PHA were called Allowable Expense Levels (AELs). They were set for most PHAs under the PFS in 1975 and subsequently updated for inflation. The AELs were modified in 1992 and again in 2001 when the interim rule was adopted. To calculate the non-utility expense component of a PHA's formula expenses under the interim operating fund formula, the number of public housing units in a PHA's inventory was multiplied by the agency's AEL. The new operating fund formula sets new non-utility expense levels for PHAs based on the data from the Harvard study and adjusted for inflation. These new project expense levels (PELs) are not applied at the agency level (as under the interim rule), rather, they differ for each project within a PHA's portfolio based on the characteristics of that project. To calculate the non-utility expense component of a PHA's formula expenses under the new operating fund formula, the number of eligible public housing units in each project in a PHA's inventory is multiplied by each project's PEL and those amounts are then summed. For the CY2007 funding cycle, HUD developed weighted average project expense levels (WAPELs) for each PHA, and applied the WAPEL to all PHA units; for CY2008 and beyond, HUD has used individual PELs. Utility expense levels (UELs) are estimates of the utility costs that can be attributed to a unit of public housing. They are calculated for each utility based on a PHA's consumption level and the applicable rates for that utility. The interim formula had aspects designed to encourage PHAs to adopt more energy-efficient practices and reduce consumption. The Harvard Cost Study did not make recommendations for changing utility expense levels, citing a lack of available data. The final rule largely maintains the existing formula for calculating UELs, although the rule does state that HUD will study options for calculating utility costs and will convene a negotiated rulemaking committee to come up with a new formula. In addition to basic utility and non-utility expenses, the interim operating fund formula included some add-on costs that PHAs could qualify to include in their formula expenses. Some of these add-ons were flat per-unit per-month or per-unit per-year fees; others were open-ended reimbursements. The new operating fund formula includes several new add-ons, including the reasonable cost of a self sufficiency program; an asset management fee for PHAs in compliance with asset management requirements ($4 per unit per month for PHAs with more than 250 units and $2 per unit per month for PHAs with 250 units or less); information technology fees ($2 per unit per month); asset repositioning fees (for units being removed from the public housing stock that are not eligible for operating funds); reasonable costs for energy conservation measures; and payment in lieu of taxes (PILOT) costs (which were included in the AELs under the old formula). Formula income represents the income a PHA collects from rents. Under the interim rule, formula income was calculated by computing a PHA's average monthly rental charge per unit, applying an upward trend factor, and multiplying it by the number of units expected to be occupied. Under the new operating fund rule, formula income was initially calculated by taking the average rent charged by each PHA in its 2004 fiscal year and multiplying it by the PHA's eligible units. Each PHA's formula income was frozen at this 2004 level through the CY2009 funding cycle. Because tenants in public housing pay an income-based rent, as their incomes rise, so does the amount they pay in rent. With formula income frozen at the 2004 level, PHAs were provided an incentive to encourage families to increase their incomes, as the increased revenue from rents was not used when calculating a PHA's operating fund eligibility until after 2009. According to HUD, "unfreezing" income in 2010 resulted in the accounting for an additional $400 million in rental income over 2009. Under the new formula, some PHAs were "gainers," meaning that they were eligible for an increase in funding under the new formula as compared to the amount of funding they would have received under the old formula. Others were "decliners," meaning that they qualified for less funding under the new formula then they would have if the old formula had been maintained. A HUD analysis found that 74% of PHAs would have qualified for higher funding if the new operating fund formula had been in place in 2004; 26% of PHAs would have qualified for less funding. To help ease the transition, losses will be phased in over five years; gains were phased in over two years (see Table 1 for the phase-in schedule). To implement the phase-in, HUD calculated a transition amount for each PHA. The transition amount was the difference between a PHA's operating subsidy eligibility in 2004 and what the PHA's eligibility would have been if the new formula had been in effect. The transition amount for each PHA was adjusted by each year's phase-in level and then either added to or subtracted from each PHA's operating subsidy eligibility level for that year. For example, if a PHA's operating subsidy eligibility was $500,000 in 2004 but would have been only $450,000 if the new formula had been in place, the PHA would be considered a decliner, and its transition amount would be $50,000. Under the phase-in schedule, declines are limited to 5% in the first year, and so $47,500 (50,000 x 95%), would have been added to the PHA's 2007 operating subsidy eligibility. If the situation were reversed and the PHA would have gone from $450,000 under the old formula to $500,000 under the new formula, the PHA would be considered a gainer. Its transition amount would still be $50,000, but since gains are limited to 50% in the first year, $25,000 would have been subtracted from the PHA's 2007 operating subsidy eligibility. PHAs wishing to limit their losses can transition to asset-based management before the 2011 deadline (discussed below). PHAs that transition to asset-based management in the preceding year stopped their losses for the following year and thereafter at that year's phase-in rate. For example, a PHA that adopted asset-based management by the deadline in the first year would have limited its losses to 5%, meaning that HUD will add 95% of its transition amount to its operating subsidy eligibility each year. One major recommendation of the Harvard study was that PHAs should transition to asset-based management. In the past, PHAs budgeted and were funded on an agency-wide basis, rather than on a project-by-project basis. They were also permitted to manage all of their units from a central office. This system differed from private market multifamily housing norms, where each property is treated as an individual asset and managed on an individual basis. In the final operating fund rule, HUD directed PHAs to adopt project-based budgeting and project-based accounting by PHA FY2007, and project-based management by PHA FY2011. The amount of operating subsidy a PHA is eligible to receive is not necessarily the amount of funding it will actually receive. The amount of funding appropriated by Congress for the operating fund is generally less than the amount necessary to fund all PHAs at 100% of their eligibility. As a result, HUD must apply an across-the-board cut to PHAs' operating subsidy levels in order to stay within the amount appropriated by Congress. The percentage of formula eligibility PHAs receive after the across-the-board cut is referred to as the proration level. As shown in Table 2 , for several years proration levels were declining, meaning that PHAs were receiving a smaller and smaller share of the total funding for which they are eligible. Proration levels began increasing in recent years and reached over 100% in CY2010. The substantial increase in proration in CY2010 appears to be due, in part, to the effect of "unfreezing" formula income, which accounted for an additional $400 million in formula eligibility that did not have to be met through subsidy. Without the "unfreezing" of formula income, the proration level in CY2010 would have been about 94%. The Harvard Operating Cost study found that, on the whole, the government has been under-funding the operating costs of PHAs. HUD's own transition analysis indicated that if the new formula had been in place in 2004, PHAs would have been eligible for an additional $264 million. That means that if the new formula had been in place in 2004, with the same appropriations level, the proration level for 2004 would have been lower (and PHAs would have received less than 98% of their funding eligibility).

Summary: The local public housing authorities (PHAs) that administer the federal public housing program began receiving their annual federal operating subsidies under a new formula in January 2007. As a result of this formula change, some PHAs were eligible for an increase in their eligibility for funding and others were eligible for a decrease. Both the increases and the decreases were phased in (over two and five years, respectively) and PHAs that faced declines were eligible to limit their losses by adopting management reforms—which were also a part of the new operating fund requirements—earlier than required. Since the formula is only used to determine eligibility for funding, the amount that a PHA qualifies for under the formula (whether it is an increase or a decrease) will be reduced if Congress appropriates less money than is necessary to fund all agencies at 100% of their eligibility, which it has done in the past.