Federal actions are causing DC to lose one of its stellar credit ratings, which will raise the cost of borrowing and could harm DC’s increasingly fragile economic outlook. This week, a major credit rating agency—Moody’s Ratings—downgraded slightly DC’s triple A bond status, and at least one other agency—Fitch Ratings—announced it also will review its rating for DC. These moves were triggered by mass federal layoffs and federal legislation that could force massive cuts to DC’s budget through September. Higher borrowing costs for infrastructure projects will exacerbate already intense budget pressures for the District but lawmakers can improve stability by raising revenue.
Moody’s downgrade happened even though DC is, and has long been, a picture of fiscal responsibility. Unlike any other state in the nation, DC operates on a four-year financial plan that requires balancing future year budgets with each new budget year. DC has had 28 consecutive clean audits and balanced budgets, through good and bad economic times, and has budgeted more than $1 billion in rainy day funds. DC law limits how much the District can borrow, known as a debt limit, capping debt service payments at 12 percent of the general fund budget and keeping capital spending through bond issuance in check.
Reckless federal actions that shape DC’s fiscal and economic outlook, all of which matter for credit ratings, are driving Moody’s and potential additional credit downgrades, alongside ongoing weakness in the commercial real estate market. Without voting representation in Congress and the autonomy of other states, DC has little recourse against these federal attacks. But lawmakers do have tools available for stabilizing DC’s fiscal outlook and stemming further negative actions by credit agencies. In fact, the rating criteria laid out by agencies such as Moody’s and Fitch indicate that revenue adequacy and stability—which make it possible for DC to pay debts to bondholders—are key components of their ratings. For example:
- The ability to raise “own source” revenues is a key component across the four factors that make up Moody’s ratings framework—economy, financial performance, institutional framework, and leverage. These factors hinge on the “structural balance” between revenues coming in and fixed costs (things that must be paid), liquidity in terms of fund balances and reserves, and the authority a government has to raise revenue, cut spending, or both.
- Likewise, a government’s “Revenue Framework” is one of four key ratings drivers for Fitch Ratings. This includes revenue growth outside of revenue raising measures and the independent legal ability to raise operating revenues without external approval, like a voter referendum, when revenues decline. (Note: the agency excludes political difficulties raising revenue in this assessment.)
These criteria are similar to those of other ratings agencies. For example, S&P’s index prominently includes revenue adequacy as a criterion, including that revenue matches expenditures and favoring states without limits on raising revenue like supermajority vote requirements.
The common theme and primary concern of ratings agencies is that a jurisdiction achieves structural balance in terms of maintaining its ability to pay its debts and to do so without undue harm to its commitment to reliably provide core public services. The only caveat from Moody’s is that revenue raising not go so far as to drive outmigration (i.e., causing residents to leave DC).
However, analysis by DC’s Tax Revision Commission of the effect of an income tax increase in 2021 showed that not only did the tax increase not cause outmigration, but that DC actually grew its number of high-income filers in the year following. The unlikelihood of mass tax flight is also borne out by research, including scholar Cristobal Young’s investigation of millionaire migration, showing that the magnitude of the effects of taxes on migration would need to be 8 to 15 times higher for it to be a relevant consideration in tax policy decisions.
In the face of federal threats and slowing revenue growth due to mass federal layoffs, DC lawmakers should make use of a key policy tool well within their control—the ability to raise revenue.
In fact, DC can pursue structural reforms to its revenue system that fill gaps left by declining revenue sources, broaden its revenue base, and build greater resilience for future years. For example, DC can close loopholes in its business tax system with a business activity tax, ensuring all businesses benefiting from the DC economy fully contribute to shared resources. More immediate revenue raisers, like taxing wealth and high incomes, should also be on the table to improve DC’s fiscal outlook. These options won’t negate spending cuts due to federal attacks on DC’s budget autonomy, but a balanced approach that includes revenue would help DC’s structural balance of revenues and spending in a time of uncertainty.
