Meeting DC’s Challenges, Maintaining Fiscal Discipline: Improving the DC-Federal Relationship
Summary
Maintaining good relations with the federal government is very important for the District of Columbia. The federal government’s oversight authority over the District means that all legislation adopted by the District must be approved by the Congress. In addition, the District’s annual budget is adopted as part of the federal budget, even though two-thirds is supported by local tax dollars and the federal funds DC receives generally are for programs that serve all the states. Because the DC budget is part of the federal budget, the Congress has the authority to modify any portion or set restrictions on how the District spends its resources.
There has been tremendous progress in the relationship between the federal government and the District of Columbia over the past decade. As the city’s finances stabilized, the federal financial control board that had been established in 1995 was disbanded in 2002, and congressional appropriators have shown greater deference to the District’s budget priorities. In addition, there was a bi-partisan effort in Congress in 2006 to give DC full voting rights in the House of Representatives. While the Voting Rights Act was not adopted, it represented substantial progress toward full Congressional representation.
The new Democratic majority in Congress presents an opportunity for the District to improve its relationship with the federal government even further. In addition to continued work on voting rights, there will be opportunities to seek greater autonomy, particularly in the area of its budget. The possible action items include:
- Putting an end to “budget riders” that restrict how DC spends its own funds. When the Congress approves the DC budget, it often includes "riders" that restrict how the District can spend its own tax dollars. For example, the federal government has prohibited the District from offering a needle exchange program for addicts, even though such programs help prevent HIV and other infectious diseases. Until 2006, the Congress did not allow the District to spend funds to support educational efforts on the District’s lack of congressional voting rights. The District should work with the Congress to eliminate harmful budget riders.
- End federal restrictions on DC’s Rainy Day Fund: In 2001, the Congress required the District to establish a rainy day reserve, which now is stocked with $260 million in local funds. Yet the federal law also set very tight restrictions on when the funds could be used and when they would have to be repaid ‘tighter than the rules of any state rainy day fund. The District should work with Congress to ease these restrictions and allow the District to set its own rules.
- Promote a federal contribution to address the District’s structural budget imbalance. A 2003 study by the Government Accountability Office confirmed that the District of Columbia faces a large gap between its ability to raise revenues and the cost of providing basic services. DC’s revenue capacity is limited by a federal prohibition on taxing the income of people who work in the city but live outside it, which represents roughly two-thirds of those who work in DC. In addition, roughly one-third of DC land is exempt from the property tax, including federal properties, embassies, and non-profits. GAO found that the District could not eliminate this gap simply by improving efficiency. Legislation has been introduced in the Congress in recent years, but not adopted, to create an $800 million annual contribution to the District with annual inflation increases.
For more information, see the following DC Fiscal Policy Institute reports:
A New Federal Contribution To The District of Columbia? The Need, Likely Impact, and Some Options (published jointly with the Brookings Institution), November 2005 (http://dcfpi.org/?p=36)
Fixing DC’s Rainy Day Fund
March 2003 (http://dcfpi.org/?p=73)
Issue I: Fixing DC’s Rainy Day Fund
In 2000, the U.S. Congress required the District to establish two “rainy day” reserves as a cushion against major crises that could disrupt the budget ‘ such as a natural disaster or a drop in revenues during an economic recession. Rainy day funds can play a significant role in helping states and cities manage a fiscal crisis. In particular, they provide fiscal stability during an economic downturn, when revenues tend to fall but the need for government services rises.
The District has set aside $260 million in local tax dollars in these reserves. Federal rules governing DC’s rainy day fund are so restrictive, however, that the city would face difficulty accessing these funds even in the midst of a budget crisis. The following provisions make DC’s rainy day fund one of the most restricted in the nation.
Funds withdrawn from the DC rainy day fund must be replenished within two years. Because a fiscal crisis can last more than one year, this rule could require the District to repay a withdrawal before its finances have recovered. Some 39 of 45 states with a rainy day fund have no requirement to replenish it in a specific period of time. These states typically re-build their rainy day funds when their finances recover ‘ such as when they have a budget surplus.
DC’s rainy day fund can be used only if revenues decline dramatically. The District can tap its reserve only if revenue collections in a given year fall more than five percent below the amount assumed in the budget. For 2007, this would mean that revenue collections would have to fall $250 million below current projections, an unlikely occurrence. Most state rainy day funds give policy makers great flexibility to determine when to use the reserves. In 21 states, the rainy day fund can be used when the state faces a budget shortfall for any reason — either because expenditures are higher than expected or revenues are lower than expected, or both. In another 18 states, the rainy day fund can be tapped only to address revenue shortfalls, but the shortfall can be of any amount; it does not need to be a steep shortfall as is required in the District.
The uses of DC’s rainy day fund are restricted. The DC rainy day fund has two components. One of them, with $75 million in 2007, can be used only in a natural disaster or a declared state of emergency. No other state restricts their rainy day fund in this way. Instead, most states have full access to their reserves for either a natural disaster or economic downturn.
District officials could work with the Congress to relieve the most restrictive elements, to ensure that reserves are built up when fiscal conditions are strong, and to allow DC policymakers greater access to the fund when budget conditions deteriorate.
- Abolishing the two-year replenishment rule. Like most states, the District should be required to devote annual budget surpluses to the rainy day fund whenever it is below the target level.
- Allowing the rainy day fund to be used for either a natural disaster or a revenue shortfall. This could be accomplished by combining the two components of DC’s rainy day fund into one.
- Allowing the rainy day fund to be used whenever the city faces a budget deficit ‘ or whenever the District faces a revenue shortfall ‘ as most states do. Typically, state policymakers are cautious about using their reserves and tap them only when budget conditions deteriorate significantly. This is likely to be the case in the District as well.
Beyond these reforms, District officials should consider increasing the size of the city’s rainy day fund. Analyses of state-level budget shortfalls during economic recessions suggest that a reserve that equals from 10 percent to 15 percent of the state’s budget is needed to weather a multi-year revenue downturn. The District’s reserve equals six percent of its budget. DC could increase the size of its reserve even in the absence of federal changes, by creating a new separate reserve that would be governed entirely by local rules.
For more information, see the following DC Fiscal Policy Institute report:
Fixing DC’s Rainy Day Fund
March 2003 (http://dcfpi.org/?p=73)
Issue II: An Annual Federal Contribution to Address DC’s Structural Imbalance
A 2003 study by the General Accountability Office confirmed what DC leaders and academic analysts have noted for years: the District of Columbia faces a large gap between its ability to raise revenues and the cost of providing basic services. The study found that the structural imbalance results directly from factors related to DC’s unique status as the nation’s capital.[1]
- The costs of delivering services in the District are far higher than in any other state: The District faces many factors that put upward pressure on its budget’such as a high cost of living and significant public safety and social service needs. To provide just an average level of services, GAO found, DC must spend more than any other state. Yet the District is not embedded in a larger state that can help share this load. For example, sixty percent of the metropolitan area’s homeless residents, for example, live in DC.
- DC’s revenue capacity is restricted significantly by the federal presence: Federal law prohibits the District from taxing the earnings of people who work in the city but live outside it ‘ roughly two-thirds of those who work in DC. Every state with an income tax, by contrast, has a non-resident income tax. The federal prohibition costs the District roughly $1.4 billion every year. DC’s revenues also are limited because one-third of its land is owned by the federal government, foreign governments, or non-profits, and thus is tax-exempt. The federal government also does not pay corporate income tax or sales tax.
The GAO found that DC’s structural imbalance is in the range of $470 million to $1.1 billion per year, depending on which assumptions are used. A review of these assumptions by the DC Fiscal Policy Institute and the Brookings Institution suggests that the most reasonable estimate is between $900 million and $1.1 billion.
One result of DC’s structural budget imbalance is a long-term under-investment in physical infrastructure. DC public schools, for example, are, on average, 65 years old. The most recent estimate of deferred capital needs for the city as a whole is in the range of $5.2 billion over the next six years, and this was not a thorough assessment. Yet the District’s debt is now far higher than any state’s on a per capita basis, making it virtually impossible to address its full infrastructure backlog.
Despite these challenges, the District has balanced its budget for nine years in a row and enjoyed upgrades in its bond rating. This progress, however, has been built largely on an unusual ‘ and perhaps temporary ‘ upsurge in its real estate market, and it does not change the fundamental fact that the District faces substantial public service costs and a restricted tax base.
Further federal efforts to address the DC’s structural imbalance are warranted. To be effective, a federal contribution must be stable and predictable, and it must allow the District to address its most pressing needs.
A Federal Contribution Could Help DC Address the Impacts of its Structural Imbalance
A bill introduced in recent years by DC Congresswoman Eleanor Holmes Norton and endorsed by the entire congressional delegation from the Washington region would provide the District with $800 million annually (adjusted each year for rising costs) to address a variety of infrastructure needs. This bill, which has not been adopted, would devote $800 million to a dedicated fund that DC could use for repayment of bonds, school construction, information technology, and transportation costs, including DC’s share of Metro system expenses. This bill would help the District address deferred infrastructure needs without raising its debt. It also would allow the District to use these federal funds for certain operating expenses, such as debt payments, which could free up funds that the District could use to address high service costs in other areas.
Another option for setting the size of a federal contribution would be to measure the services provided by the District that are funded at the state level elsewhere. Each year the District spends at least $1.2 billion on services that typically are funded entirely at the state level. This includes costly program areas, such as mental health and foster care.
For illustration purposes, it is worth exploring the impact of dividing the federal funds among these purposes equally. The $800 million fund would support nearly $270 million for each of these functions if divided equally, which would have the following effects:
- Addressing Unmet Capital Needs: Devoting an additional $270 million in federal funds to these projects would enable the District to address roughly one-third of its deferred maintenance projects.
- Reducing DC’s Substantial Debt: Outstanding general obligation debt now totals $3.6 billion and is growing at a rate of about $100 million per year. Using $270 million in federal funds to finance currently planned projects’using “paygo” financing’would reduce the District’s outstanding debt by nearly half over 10 years.
- Offsetting High Costs of State-Level Services: $270 million would cover roughly one-fourth of state-level functions the city now provides.
In short, federal compensation for DC’s structural imbalance would allow the city to make substantial progress on some its greatest challenges and become an even more welcoming place as the nation’s capital.
For more information, see the following DC Fiscal Policy Institute/Brookings Institution report:
A New Federal Contribution To The District of Columbia? The Need, Likely Impact, and Some Options (published jointly with the Brookings Institution) November 2005 (http://dcfpi.org/?p=36)
End Notes:
[1] Government Accountability Office, 2003, “District of Columbia Structural Imbalance and Management Issues,” GAO-03-666.