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District of Columbia Home Rule Charter Review

in collaboration with
the Federal City Council


"An Overview of the Economic
and Fiscal Condition
of the District of Columbia


BACKGROUND BRIEFING REPORT

Prepared by Georgetown University's Graduate Public Policy Program


This policy briefing report is the second in a series of policy seminars supported by Georgetown University's Graduate Public Policy Program (GPPP).


The GPPP's "D.C. Project" provides faculty and student research resources as a community service to support collaborative efforts addressing the needs of the District of Columbia.

I. The Economy of the District of Columbia

A. INTRODUCTION

Governance and fiscal issues are at the heart of the discussions about the problems plaguing the District. The District government is overwhelmed with budgetary shortfalls and administrative management challenges which has led to the establishment of administrative oversight by congressional legislation. As its expenditures spiral and its revenue sources decline, the city struggles to provide services for its residents and the over one million commuters and tourists who enter the city every day (US Department of Housing and Urban Development, The Future of Metropolitan Economic Regions, Regional Economic Development in the Washington, DC Metropolitan Statistical Area, p. 2).

As the capital city of our nation and home of the federal government, the District economy is integrally linked with the federal government. The city is blessed with a rich history and world-famous monuments, public buildings, universities, and hotel accommodations. D.C. is a major transportation and communications hub, a premier center for cultural events, meetings and tourist destination. In addition to being the center of U.S. politics, D.C. is home to prominent international organizations and figures. (HUD Report, p. 12). This section will present information and analysis about the nature and status of the economy of the District paying special attention to such trends as the specialization of the D.C. economy, downsizing of government, the outmigration of the middle class and the high percentage of District workers living in the suburbs (HUD Report, p. 12).

B. BACKGROUND

Over the last twenty-five years the District's economic well-being has been shaped by:

í the structural changes that have resulted in the District's economy becoming more specialized while the suburban economy has become more diversified, and
í the geographic shift of jobs and economic activity away from the District economy and to the suburban economy (Fuller, The Economy of the District of Columbia: Its Changing Structure, Importance to the Region and Opportunities for Future Growth, p. 6-7).

The contribution of the District economy, as a direct source of income within the metropolitan economy, has been declining for many years as economic activity has grown more rapidly in the suburbs. The District's share of the region's gross regional product is estimated to have dropped to less than 26% in 1996; in 1970, it constituted almost 43% (Fuller, p. 9) (See Table 1).

Table 1
Gross Regional Product, 1970-1996
District of Columbia and Washington Area
(in billions of 1995 dollars)
District
Suburbs
Metro Area
DC /PMSA
Year
Dollars
% Change
Dollars
% Change
Dollars
% Change
Percent
1970
30.7
-
41.0
-
71.7
-
42.8
1975
33.7
1.3
54.6
6.6
88.4
4.6
38.2
1980
35.2
0.9
63.5
3.2
98.7
2.4
35.7
1985
37.0
1.0
85.2
6.8
122.2
4.8
30.3
1987
38.7
2.2
96.9
6.9
135.6
5.5
28.5
1988
41.0
6.1
102.9
6.2
143.9
6.2
28.5
1989
41.5
1.1
107.7
4.7
149.2
3.7
27.8
1990
41.4
(0.20)
106.1
(1.5)
147.5
(1.1)
28.1
1991
41.4
-
105.1
(1.0)
146.5
(0.7)
28.3
1992
42.3
2.0
106.4
1.3
148.7
1.5
28.4
1993
43.2
2.3
110.2
3.6
153.5
3.2
28.2
1994
43.8
1.3
114.1
3.5
157.9
2.9
27.7
1995
42.9
(2.0)
119.0
4.2
161.8
2.5
26.5
1996
42.7
(0.6)
122.0
2.5
164.7
1.7
25.9
Note: Area is defined as the PMSA; % change is annualized
Source: Fuller, Stephen. "The Economy of the District of Columbia: Its Changing Structure,
Importance to the Region and Opportunities for Future Growth." Working Paper 1996.

In the past four years, the District's share of the region's economy has declined at an accelerated pace. This loss of share coincides with the programs of the Clinton Administration to downsize the federal workforce and "reinvent" government. As a consequence of federal policy changes associated with the National Performance Review, the federal workforce has decreased by more than 30,500 full-time jobs in the Washington area in the three years since its July 1993 peak (Fuller, p. 9).

C. EMPLOYMENT

Employment in the District continues on its downward course of the past six years, despite a small increase in July 1996 from 634,200 to 642,200. The federal government has eliminated 9,800 jobs in D.C. from June 1995 to June 1996, while the D.C. government has eliminated another 1,500 jobs in the same period. Employment in the last year has declined by 14,700 jobs (June to June). Most of that was in the public sector (11,300 jobs); some of it was in the private sector (3,400 jobs) (Center for Business and Economic Statistics, D.C. Economy, Vol.5, No.4, October, 1996 p. 3).

The District labor force - District residents who are able and willing to work - has been declining at an accelerating rate since January 1995. According to D.C. Economy figures, which have been adjusted for definitional changes and seasonal variation, the labor force has declined by 25,520 since January 1995. The unemployment rate has turned up again in the past few months rising to 9.2% in July 1996 among the highest in the nation among cities(Center for Business and Economic Statistics, p. 3-4). However, the Washington D.C. metropolitan statistical area (MSA) had the 10th lowest unemployment rate in the country at 4.2% in July 1995 (HUD Report, p. 8).

D. DEMOGRAPHIC TRENDS

During the twenty year period from 1970 to 1990, suburban Maryland's population increased 300,000 while Northern Virginia exploded from .9 million to 1.5 million. The District boasted a population of 756,510 in 1970, but by 1990 it had lost 150,000, largely to the suburbs. Another 13,000 residents left during the 12 month period ending July 1, 1995, bringing the total to well over 50,000 in the first half of the 1990's alone. The U.S. Census Bureau estimates that D.C.'s 1995 population is 554,000 (See Figures 1 and 2). The net outmigration is characterized by middle income families moving out which is reflected in the decline in income tax receipts (HUD Report, p. 7). The District lost a larger share of its population than all of the nation's 209 largest cities except Hartford and New Haven, Connecticut and St. Louis, Missouri. Prince George's County was the leading destination, followed by Montgomery County, Arlington County, Fairfax County and Alexandria. Other forecasted trends include a near doubling of persons 65 years and older and a 30% increase in the number of children (HUD Report, pp. 2, 7-8).



The Rivlin Report Revisited states that fear of crime, concern about the schools and high tax rates are pushing residents out of the District. As people become financially able, they are more likely to move to the suburbs of Maryland and Virginia, leaving behind fewer people contributing to an eroding tax base. While the tax-paying population is declining, the neediest population in the District is growing. Nearly half of the District's 116,000 children receive Aid to Families with Dependent Children (AFDC). One of every five residents receives health care assistance through Medicaid, one in six receives food stamps, and more than 60% of the metropolitan area's minority poor live in the District. The combination of these factors produces a double effect, with the loss of income tax revenue on the one hand and the increased need for services on the other (KPMG Peat Marwick LLP, Four Years Later - The Rivlin Report Revisited, p. 22-24).

The loss of the tax base endangers the District's ability to function. Table 2 presents the number of District filers by adjusted gross income. For example, 65% of filers in the District have an income less than $30,000. In addition, 33% of filers have an income less than $15,000. Only 17 % of filers have an income of $50,000 or greater (See Table 2).


Table 2
Federal Income Tax Returns of District Residents by Income Level
Adjusted Gross
Total
Percent of Total
Income Range
District Filers
District Filers
Under $15,000
97,423
33.7%
$15,000 $30,000
91,498
31.6%
$30,000 $50,000
52,386
18.1%
$50,000 $75,000
23,650
8.2%
$75,000 100,000
9,838
3.4%
$100,000 $200,000
10,280
3.6%
$200,000+
4,287
1.5%
Total
289,362
100.0%
Adjusted Gross Income is defined as total income minus IRA, Keough,
moving expenses, and alimony payments.
Source: Representative Holmes Norton's Office

D.C. Delegate Eleanor Holmes Norton introduced the District of Columbia Economic Recovery Act (DCERA) in April 1996. The DCERA is an attempt to offset the outmigration. The bill would reduce federal income tax liability for District residents in three ways:
í The standard deduction and personal exemption would be enlarged - $15,000 for single filers, $25,000 for single heads of households, and $30,000 for married joint filers (See Table 3).
í A uniform rate of 15% would be applied progressively up the income scale to reduce present tax liability.
í The mortgage interest and charitable deductions would remain (Congress. House. D.C. Subcommittee Hearing on H.R. 3244. The District of Columbia Economic Recovery Act of 1996, Opening Statement of Congresswoman Eleanor Holmes Norton, p. 1-3).

While D.C. Delegate Norton asserts that the bill would stabilize the population and spur business and economic development, an opposing view is that the bill may raise the population of poor and low-income people and place added pressure on government-provided services (Brookings Institution, "Press Release: Brookings Will Explore Options To Avert District of Columbia Insolvency," April 1, 1996).



Table 3
D.C. Economic Recovery Act Provides Sizable Progressive
Tax Reduction
Assumes a 15% rate with Exemptions of $15,000 for Single and
Married-Separate Filers; $25,000 for Head of Household Filers; and
$30,000 for Married-Joint Filers
Percent Reductions
Income Range
Number of Filers
in Tax Liability
Under $15,000
50,390
100.0%
$15,000-$30,000
87,117
79.0%
$30,000-$50,000
52,060
51.2%
$50,000-$75,000
23,568
44.2%
$75,000-100,000
9,822
36.8%
$100,000 $200,000
10,259
35.7%
$200,000+
4,286
34.2%
Total
237,502
44.3%
Source: Representative Holmes Norton's Office

E. SPECIALIZATION

The District's economy has become more specialized in the past twenty-five years while the suburban economy has become more diversified. This specialization is the first important dynamic in the area's changing economy. The principal difference that distinguishes the District's economy from that of other cities/states is the dominance of government employment which account for 36.8% of all District jobs in 1995, more than double the proportion of government workers that is found in the national economy. The private sector represents 63.2% of the District economy and of these a disproportionately large 41.8% (over specialization) were located in services. The other sectors of the D.C. economy: construction, manufacturing, wholesale and retail trade, finance, insurance, and real estate account for a combined 21.3%. This 21.3% reflects a substantial under specialization when compared with the same sectors in the suburbs amounting to 54.5% of the suburban economy which presents many more diverse job opportunities (See Table 4).

Table 4
Changing Sectoral Structure of the District Economy
Percent Employment Distribution, 1970 and 1995
District
Suburbs
United States
Sector
1 970
1 995
1 970
1 995
1 970
1995
Private Sector
5 6.6%
6 3.2%
6 4.9%
8 0.7%
8 1.3%
84.9%
Construction
3 .1
1 .4
7 .3
6 .3
5 .0
5.2
Manufacturing
2 .8
1 .9
5 .4
3 .8
2 2.6
13.2
TCPU1
5 .3
3 .2
4 .1
4 .7
5 .6
4.9
Wholesale Trade
3 .0
0 .8
2 .7
3 .6
4 .8
4.8
Retail Trade
9 .6
6 .9
1 6.9
1 6.9
1 5.7
17.1
FIRE2
6 .6
5 .7
7 .5
8 .0
7 .0
7.4
Services
2 5.6
4 1.8
2 0.3
3 6.3
1 9.2
30.4
Other
0 .6
1 .4
0 .7
1 .0
1 .4
1.8
Government
4 3.3
3 6.8
35.1 19.3
1 8.7
15.1
Federal Civilian
3 0.4
2 6.9
1 4.8
7 .6
3 .3
2.1
Military
4 .4
3 .5
1 0.2
2 .7
3 .7
1.6
State and Local
8 .6
6 .3
1 0.1
9 .0
1 1.7
11.4
1 Transportation, communications and public utilities
2 Finance, insurance and real estate
Source: Fuller, Stephen. "The Economy of the District of Columbia: Its Changing Structure,
Importance to the Region and Opportunities for Future Growth." Working Paper. 1996.

The government-related nature of the District's service sector is evident in the high proportion of jobs in membership organizations, legal services, services to buildings, hotels/motels, personnel, education, and engineering and management services (See Table 5). Moreover, the District's economy has become less diverse over the past 25 years in contrast to the Washington suburban and national economies. In other words, the District's principal private sector economic functions are substantially interdependent with its federal functions and have become more so in recent years (Fuller, p. 4). This lack of diversity makes the District economy more vulnerable to changes in federal spending than its suburbs (Fuller, p. 2-5). The downsizing of government has a rippling effect on the economy, experienced most recently in the government shutdowns of fall 1995.



Table 5
Service Sector Job Distribution
District of Columbia and the Nation- June 1996
Subsectors
District
Nation
Hotels/Motels
6.1%
5.2%
Personal Services
1.2
3.3
Business Services
16.9
20.8
Services to Buildings
3.9
2.6
Personnel Supply
4.2
0.9
ADP1
2.8
3.4
Other
6.0
13.8
Health Services
14.6
27.6
Legal Services
10.9
2.7
Education Services
11.9
5.2
Social Services
5.6
6.9
Membership Organizations
13.4
6.3
Engineering and Management
15.5
8.4
All Other
3.9
13.6
Total
100.0
100.0
1 Computer and data processing services
Source: Fuller, Stephen. "The Economy of the District
of Columbia: Its Changing Structure, Importance to
the Region and Opportunities for Future Growth."
Working Paper 1996.

The District's economy has experienced only nominal growth in the overall employment base. The 10.2 % gain in jobs in the District since 1970 is well below the national pace of 64.3 % growth and compares poorly with the 146% job gain in the Washington suburbs (Fuller, p. 6). While 44% of the jobs in the metropolitan area were based in the District in 1970, between 1970 and 1985, the suburbs added 18 jobs for every one added in the District (KPMG Peat Marwick LLP, p. 24). This shift in the geographic distribution of jobs within the Washington metropolitan area is a second important dynamic in the area's changing economy. The city/suburban job distribution changes have reinforced the specialized nature of the District economy (Fuller, p. 6).

Additional factors affecting the workforce include the quality and availability of education. The District per student spending is among the highest in the nation, yet the District consistently ranks near or at the bottom
in standardized test scores. According to the Rivlin Report Revisited, the poor quality of the District's public schools is one of the primary reasons cited in residents' and businesses' decisions to move outside the District. Both the Rivlin Commission and the D.C. Committee on Public Education (COPE) in December 1994, recommended a major investment in school improvement and called for a significant reallocation of resources from administrative services to direct benefits to students (KPMG Peat Marwick LLP, p. 33-34).

The demands of the workforce are changing rapidly and by 2000, 68% of jobs will require post-secondary education (KPMG Peat Marwick LLP, p. 53-55). Post-secondary education improves employment prospects significantly, with most of this improvement coming from educational attainment below the bachelor's level. Compared to surrounding states, however, the District holds many opportunities for advanced degrees but very few opportunities to earn associate degrees. The Rivlin Report Revisited recommended that the District convert the University of the District of Columbia to a community college which would improve educational opportunities in the District (KPMG Peat Marwick LLP, p. 53-55).

Another factor shaping the District economy is the significant import of labor from the suburbs. In 1990, two-thirds of all the jobs in the District were filled by non-District residents. The consequences of this high dependency on imported labor, most of which (90%) resides in the suburbs, is a significant leakage of income out of the District economy. More than half of the personal income generated in the District economy leaks out in the form of salary and wages (this is a net value reflecting the inflow of earnings by District residents employed outside of the District) and the percentage of this net outflow has slowly increased. (See Table 6) While it is obvious that the suburban economy gains from this transfer of earnings, it is also important to recognize that the District economy would be substantially smaller in the absence of these non local labor resources (Fuller, p. 10).


Table 6
District Generated Income, 1970-1996
By Place of Employee Residence
(in billions of 1987 Dollars)
Personal Income
Personal Income
Percent
Year
Retained in DC
Leaking to Suburbs
Lost
1970
$10.63
$9.15
46.2%
1975
$11.79
$9.94
45.7
1980
$11.17
$11.53
50.8
1985
$11.96
$11.92
49.9
1987
$12.28
$12.68
50.8
1988
$12.88
$13.42
51.0
1989
$13.02
$13.66
51.3
1990
$12.95
$14.00
51.9
1991
$12.90
$14.15
52.3
1992
$13.23
$14.51
52.3
1993
$13.40
$14.74
52.4
1994
$13.47
$15.04
52.8
1995
$13.61
$14.39
51.4
1996
$13.40
$14.47
51.9
Source: Fuller, Stephen. "The Economy of the District
of Columbia: Its Changing Structure, Importance to the Region
and Opportunities for Future Growth." Working Paper 1996.

The trends and overall pattern of the District economy developed over the last 25 years have greatly accelerated during the last 10 years. The District's economy has become increasingly dependent on government and government-related services. In contrast, the suburbs have experienced rapid economic growth and become more diversified. Still, the federal government and its related services provide significant underpinning for the suburban economy as suburban labor resources continue to realize substantial economic benefits (income) from the District's economy. Similarly, the District economy continues to derive essential economic inputs from the suburbs that help to sustain an economy far larger than supportable by its residential base (Fuller, p. 12).

Contrary to the widely-held belief that the District has made little or no effort, the District implemented or partially implemented fully two-thirds of the Rivlin Commission's recommendations, saving an estimated $819 million. If the District follows through on the recommendations not yet implemented, it could realize more than $400 million in additional savings and revenues (See Table 7). It is critical to bear in mind that some of the recommendations are beyond the power of D.C. and require action through Congress.


Table 7
Rivlin Commission Recommendations To Be Considered
Millions of
Dollars per Year
Expenditures Reductions
Federal funding of pension liability
70
Create a regional transportation authority
52
Streamline procurement
25
Consolidate leased space
16
Privatize unproductive Metrobus routes
12
Reduce police staffing
30
Revenue Generation
Increase formula-based federal payment to 30%
160
increase user fees
63
Sell unoccupied real estate
30*
Increase parking enforcement
12
Allow taxation of non-resident income
Not Est.
Total
440
*One time savings, not included in total
Source: KPMG Peat Marwick LLP Four Years Later- The Rivlin Report Revisited.

In a study completed by the Mayor's Committee on Economic Development in April 1995, other economic policy priorities identified include the retention of major employers as the primary task to revitalize the city's economy. Major objectives include:

í Increasing household income by creating employment opportunities;
í Revitalizing neighborhoods including housing and commercial/ industrial corridors;
í Assisting local business, especially small and minority owned; and
í Reforming economic planning, statutory and administrative processes to improve the business climate (HUD Report, p. 22).

The Rivlin Report Revisited concludes that addressing the expenditure side of the ledger must be the first step to revitalize the District. However, efficiency alone is not going to solve the District's problems. Even if all the Rivlin recommendations were implemented, the fundamental budget imbalance would remain due to the unfunded pension liability.

II. The Fiscal Condition Of The District Of Columbia

A. INTRODUCTION

In 1990, the Commission on Budget and Financial Priorities of the District of Columbia, otherwise known as the Rivlin Commission, wrote that the District of Columbia faced an immediate fiscal crisis. Six years later, District residents and officials alike know that the District is indeed in financial trouble.

From the outset, the financing of the District of Columbia has been ambiguous, especially the contribution of the federal government. In 1800, when the District was first created, the newly establish government levied taxes and license fees in order to raise funds to pave roads, improve public health and encourage economic development. In 1805, a luxury tax was placed on whiskey, wine, slaves, and carriages and additional money was raised by holding lotteries (Furer, Washington: A Chronological and Documentary History 1790-1970, p. 21). Although Congress realized that the city faced financial constraints as a result of the large amount of tax-exempt land owned by the federal government, it never made any formal pledges of financial support during this period. Congress only provided emergency funds, never creating a continual process for allocating funds to the District.

In 1871, a territorial form of government was created after a group of local business leaders believed Congress should play a bigger role in the District's affairs. They also believed that increased congressional involvement would mean greater financial support. After the District became a territorial government however, Congress did not provide any financial support even though local taxes did not generate enough money to run the city. As a result, the Board of Public Works borrowed money from the Federal government to continue paving streets and improving the sewer facilities. In 1872, the Board was investigated by Congress for mismanagement of funds. Eventually the members were cleared of such charges but as a result of the investigation, Congress limited the debt of the District to $10 million (Diner, Democracy, Federalism, and the Governance of the Nation's Capital, p. 19).

In 1874, Congress created a temporary commission government for the District. The commission government became permanent in 1878 with the passage of The Organic Act. The Organic Act stated that Congress would contribute fifty percent of the District's budget with property taxes and licensing fees making up the rest of the budget. Congress did contribute fifty percent to the District's budget until 1921, when Congress decreased its contribution to forty percent. Each year thereafter, the federal government's contribution to the District declined so that by 1954, Congress's contribution was only 8.5% of the District's budget (Diner, The Governance of Education in the District of Columbia: An Historical Analysis of Current Issues, p. 41). Although The Organic Act benefited the city by formalizing a congressional financial commitment, Congress did not live up to its commitment.

By the early 1970's Congress was in the midst of drafting legislation to grant the District of Columbia home rule. Hearings were convened on Capitol Hill and debates began as to what should be included in home rule legislation. Initial bills granted the District autonomy over how it spent its money. However, several representatives were concerned about allowing District control of its finances. They felt that the District would not spend wisely and in the long run the financial stability of the nation's capital would be compromised (Dissenting Views, p. 131). Many representatives successfully fought for line-item control of the D.C. budget. The final bill, The District of Columbia Self-Government and Government Reorganization Act of 1973 was passed and on January 2, 1975, initiating our current form of home rule government. The federal government still held two key powers: oversight of the District's budget and control over appropriation of the annual federal payment. In addition, the Home Rule Act set limitations on borrowing in section 603(b): "No general obligation bonds or Treasury capital project loans shall be issued during any fiscal year in an amount which would cause the amount of principal and interest required to be paid ... to exceed 14 per cent of the District revenues." Even though the District was granted home rule, the new legislation left the District with little control of its financial situation.

From the inception of home rule until today, the financial condition of the District has been tumultuous. Figure 3 presents the District's annual and accumulated surplus/deficit for the years 1980-1997. This figure shows that the District has always been faced with an accumulated deficit. The District's financial crisis began to build in the late 1980's. Only through some accounting mechanisms in 1992 and 1993, such as changing the property tax year ($174 million in 1993) and transferring income from the water and sewer fund ($28 million in 1992) did the District manage to balance its books (McKinsey & Company, "Assessing the District of Columbia's Financial Future," p. 3). When those accounting changes are taken into account, the District's fiscal condition looks even bleaker.

In April of 1995, Congress passed The District of Columbia Financial Responsibility and Management Assistance Act, which established a five member control board to oversee the District. The bill "gave the board broad power to reorganize city government, slash program and reject union contracts if city officials did not cut spending" (CQ Researcher, p. 1047). Although the boards role was initially played down by Andrew F. Brimmer, the head of control board, the control board has recently taken aggressive steps to reorganize the District. In November, the control board fired the school superintendent, hired a replacement, and created a new panel to oversee the school system. These moves reduced the role of the elected school board and created a new era in District politics. Advocates of the control board hope that it will continue to move swiftly to change the financial condition of the city.

The Control Board and District officials are presently facing a fiscal crisis. This crisis is made up of two components: revenues and expenditures. How the District raises its revenue and how it spends that money is essential to understanding the financial condition of the District.

B. REVENUES

According to a 1994 McKinsey & Company study, "two-thirds of the District's financial problem is on the revenue side." Figure 4 presents the District's general fund revenues for 1993-1997. This figure shows an overall decline in revenue from $4.5 billion in 1993 to a projected $3.9 billion in 1997 (GAO/T-AIMD-96-133, District Government: Information on Its Fiscal Condition, p. 5). That decline is represented by declines in all three sources of the District's general fund: the federal payment, operating grants, and local revenues. The federal payment is the annual amount that the federal government pays the District to compensate for the federal government's presence in the District. Operating grants consist "mainly of reimbursements and grants from the federal government for the costs of social service programs, such as the federal share of Medicaid" (GAO/ T-AIMD-96-133, p. 7). Local revenues constitute the taxes collected from property, income and sales. The two main sources of revenue for the District are local taxes and the federal payment

Taxes

Approximately 50% of the District's revenue comes from property, income, and sales taxes. When compared to other cities who receive only 15% of their revenue from taxes, it becomes apparent that a small change in tax revenue has a large impact on the District.
Property Tax: Property taxes in the District increased until 1993. After 1993, there has been a downward trend. There are several explanations as to why the amount of tax collected on property is less than what one might expect:
í The District's inability to collect tax on a large amount of tax exempt buildings and land owned by the government and other exempt entities. 57% of the District land is non-taxable, compared with 11% regionally (CQ Researcher, Governing Washington D.C., p. 1040).
í The real estate bust of the 1990's. "In the late 1980s, 20 million square feet of commercial space was added annually, but since mid-1990 there has been virtually no commercial starts" (Parham, Washington Post, "Commercial Developers, Seeking New Use for Skills," 9/14/92, p. F10). This decline had a large impact on both the value of new buildings and already existing property.
í "Consolidation of federal office space, increased competition from suburban office space, and the downward renegotiation of rents on existing space" (GAO/T-AIMD-96-133, p. 6).
í A decline in housing values and resident sales in most District neighborhoods.

In addition, revenues raised from property taxes are expected to decline even more in 1996 and 1997, with this downward trend likely to continue in the future (GAO/T-AIMD-96-133, p. 7).

Income Tax: The District of Columbia ranks number 1 among the 15 largest U.S. metropolitan areas in per capita income (McKinsey & Company, Appendix A). Yet, the high per capita income misleads people into believing that the District has a large high income population when in fact it has a small percentage of very high income residents and a large percentage of residents with income less than $15,000. Because of the disproportionate share of low income residents the District does not collect as much income tax revenue as many would think. In addition, there are several reasons why the District collects a small amount of revenue from income tax:

í The decline in the population in the past quarter century, from 757,000 in 1970 to 570,000 in 1994, most of whom were middle class income households (Bureau of the Census, Statistical Abstract of the United States, 1995, p. 28). The flight of the middle class also led to a decline in the number of remaining residents with jobs (McKinsey & Company, p. 6). A lower income population means a smaller tax base.
í The inability to tax nonresidents who work within the District as forbidden in the Home Rule Act. "Two of every three dollars earned in the District of Columbia is earned by the nonresident" (McKinsey & Company, p. 6).
í The recession of the early 1990's. The 1990-1991 recession left the District with a depressed income, which meant less tax collections and an unbalanced budget (Henderson, Washington Post, "D.C. Budget Deficit Could be $20 Million," 7/18/91, p. C4).

Sales Tax: Between 1988 and 1993, taxable sales in the District fell from over $7 billion to less than $6 billion (McKinsey & Company, p. 7). The factors that have influenced the amount of sales tax collected in the District are:

í The increase in retail developments outside of the city.
í The flight of the middle class. Along with taking the income tax base, the middle class now took their disposable income and shopping habits to the suburbs.
í Inability to collect sales tax from diplomatic and military customers.
Federal Payment

The District of Columbia's revenue raising capabilities are hindered by the presence of the federal government (loss of taxable land, inability to tax nonresidents, restrictions on heights of buildings). As a result, the District receives an annual federal payment to compensate for this burden. Historically, the federal payment has been inconsistent due to changes in the method and calculation used to determine its amount. Many feel that the federal payment is inadequate compensation. In fiscal year 1992, "Congress adopted a formula to set the general purpose portion amount of the payment to 24 percent of the second prior fiscal years' own-source revenues (local revenues) collected in the District," (GAO/T-AIMD-96-133, p. 7) which ironically meant that the as the District experienced declines in its revenues, the federal payment declined as well. Additional funds were added on to the federal payment for certain initiatives.

In 1995, that formula was discontinued and replaced with a set payment of $660 million. District officials project the payment to remain at that level until 2000 (GAO/T-AIMD-96-133, p. 8). Although discontinuing the revenue based formula was beneficial, setting the amount at $660 million until 2000 has a cost. GAO projects that with inflation, the District will actually lose about $116 in purchasing power during that period (GAO/T-AIMD-96-133, p. 8).

C. EXPENDITURES

In addition to how the District raises its revenue, how it spends that revenue is equally important to the fiscal condition of the District. Table 8 presents the District budget by each type of service. This table shows that expenditures for public safety and justice and health and human services account for more than half of the 1997 budget. Although District expenditures have declined by more than 10 percent since 1993, (CQ Researcher, p. 1041) four expenditures areas prevent the District from bringing spending under control: the unfunded pension liability; Medicaid expenditures; subsidy payments for D.C. General and UDC; and cash flow problem and debt service.


Table 8
Where the District's Money Goes
Fiscal 1997 Budget
Dollars
Expenditure
(in millions)
Percent
Control Board
3
0.1%
Financing
398
8.8%
Government Direction and Support
134
3.0%
Economic Development and Regulation
149
3.3%
Public Works
296
6.5%
Education
769
16.9%
Health and Human Services
1,690
37.2%
Public Safety and Justice
1,100
24.2%
Total
4,539
100.0%
Note: The total does not include $600 million for self-supporting off-
budget programs such as the D.C. lottery and water-sewer authority.
Source: CQ Researcher, Governing D.C., Vol. 6, No. 44, 11/22/96

Unfunded Pension Liability:

"The District of Columbia government faces many financial difficulties, but none is more grave and less understood than the mushrooming unfunded liability of the pension plans" (D.C. Appleseed Center, The District of Columbia's Pension Dilemma--An Immediate and Lasting Solution, p i). The current payment the District makes for normal costs of the pensions has become a problem for the District.

The District's pension plans dates back to the early part of the century when Congress created and authorized funding for pension plans for police officers and firefighters, teachers, and judges. However, the funding method was not consistent with actuarial principles which normally provided that moneys be put aside each year to ensure adequate funds were available to meet pension obligations in the future (GAO/HEHS-95-40, "District Pensions: Federal Options for Sharing Burden to Finance Unfunded Liability," p.6). The federal government had created a "pay-as-you-go" method to fund District pensions. When Home Rule was enacted, the federal government transferred $2.7 billion in pension liability to the District with one payment of $38 million to help offset the cost of the unfunded liability.

In 1979, Congress realized that the unfunded liability was a problem and enacted the District of Columbia Retirement Reform Act of 1979, which authorized 25 years of annual federal payments of $52.1 million to help fund these liabilities and reduced benefits. The liability has grown to $4.7 billion today and is expected to reach $7 billion by 2004, the year federal payments are supposed to stop (GAO/T-AIMD-96-133, p.12 ). At that time, federal law will require that the District make payments of $490 million above normal costs every year indefinitely just to freeze the unfunded liability at $7 billion (D.C. Appleseed Center, p. 12). This payment of $490 million equals 10 percent of the current general fund expenditures of $5 billion (D.C. Appleseed Center, p. 13). The District cannot support such large payments indefinitely.

Medicaid Expenditures:

Unlike most cities whose Medicaid programs are financed by the state and the federal government, the District of Columbia is responsible for 50 percent of all Medicaid expenditures. The other 50 percent is paid for by the federal government. Because the District is responsible for half of all spending on Medicaid, an increase in the costs can be extremely detrimental to the District's budget. Medicaid expenditures in the District of Columbia have been growing at an alarming rate since the late 1980s. Figure 5 presents Medicaid expenditures for the years 1984-1994. This figure shows the sharp increase in expenditures for the program.


The increase in expenditures is due to three factors:
í Increase in the eligible population. Federal mandates and local efforts in the late 1980s to cover more pregnant women and children, as well as expand coverage to assist low-income Medicare beneficiaries are the main cause of the increase.
í Medical price inflation and growth in utilization.
í Legislative action mandating that Medicaid's reimbursement levels for particular services, such as nursing home care be reasonable relative to the cost for such service.

The increased cost of the Medicaid program over the last ten years has forced the District to allocate an increasingly larger portion of its budget to Medicaid.

Subsidy Payments

An additional expenditure that does not take up a large portion of the District budget but is politically relevant is the subsidy for the public hospital and higher public education. Unlike most cities, the District of Columbia pays subsidies to a public hospital, D.C. General, and a university, the University of the District of Columbia (UDC). D.C. General Hospital is the only public hospital in the District and is presently facing severe financial problems. The District spent $57 million on D.C. General in 1995 and is expected to make similar payments in future years. Recent legislation has been enacted by the city council to create a Public Benefits Corporation to oversee hospital operations and integrate care between the pubic hospital and clinics. Supporters hope that the creation of the PBC will help to solve the operational and financial problems of the hospital. Nonetheless, these subsidy payments are a drain on the District budget.

In addition, the District paid subsidies to both UDC and the D.C. School of Law. In 1995, the District gave a subsidy to UDC of $50 million. The District has been cutting back on its payments in recent years from $68 million in 1993 to projected payments of $43 million and $44 million in fiscal years 1996 and 1997, respectively (GAO/T-AIMD-96-133, p. 14). Even with a subsidy, UDC is facing a financial crisis and is presently trying to determine if it will have to close its doors in the Spring. The District has also been providing a subsidy to the D.C. School of Law, which was created in 1987. In fiscal year 1992, that subsidy amounted to $4.29 million (D.C. Office of Policy and Evaluation, Indices, A Statistical Index to District of Columbia Services, December 1993, p. 270). There has been recent discussion about the future of the School of Law, specifically about whether it should continue, be closed down permanently, or consolidated under UDC.
Cash Flow Problem and Debt Service

The last major expenditure item that the District is currently grappling with is its cash flow problem and debt service. The District has had a cash flow problem for the last several years. In 1994, the District delayed pension, vendor, and Medicaid payments, and borrowed internally from its capital projects fund. In 1995, the District deferred payments again, and was expected to begin 1996 with approximately $200-300 million in delayed payments to vendors. As a result of its cash flow problem, the District has borrowed against future federal payments from the U.S. Treasury. These payments must be repaid within 12 months. GAO estimates that 1996 borrowing against the 1997 federal payment totaled $639 of the $660 million allocated (GAO/T-AIMD-96 133, p. 16). However, this short term borrowing is not solving the District's cash flow problem

Because of its financial crisis and short term borrowing, the District has had trouble securing long term financing and the interest cost of obtaining financing in the capital markets is costly. If the District is to fix its cash flow and deficit problem it will need to secure long term borrowing. However, the Home Rule Act only allows the District to issue long term general obligation bonds for capital improvements or to refund outstanding indebtedness. Section 603(b) of the Home Rule Act states that the District cannot issue general obligation bonds if the District's debt service exceed 14 percent. By the end of 1996, the District's debt service is forecast to be approximately 11.9 percent of estimated revenues (GAO/T-AIMD-96-133, p. 17). Without new provisions to allow the District to either borrow long term from the Treasury or issue long term bonds, the District will find itself severely limited in obtaining financing to continue its operations. It is hoped that the control board will solicit Congress to change current law and allow the District to secure long term financing.

D. OPTIONS FOR THE FUTURE

The present fiscal condition of the District of Columbia is perilous. Major reform is needed to solve the present problems and provide a plan for future prosperity. Several suggestions include: changing the tax obligations, returning certain services to the federal government, changing the federal payment, and studying the actions of other city control boards, such as New York City or Philadelphia.

Tax Changes

Changing the tax structure in the District of Columbia is a complex undertaking since the District must seek congressional action in order to change the present system. Two tax changes that have been suggested are: reducing the federal tax obligation of District residents in order to stimulate the economy and instituting a non-resident tax.

In April, Delegate Eleanor Holmes Norton introduced the District of Columbia Economic Recovery Act (DCERA). This bill is designed to stop the migration out of the District and to stimulate the economy. The DCERA would allow District residents to "claim tax breaks sizable enough to make up for the city's many financial and urban problems" (Norton, Washington Post, "Why D.C. Needs a Tax Break," 7/21/96, p. C7). In addition, the bill calls for a top federal tax bracket of 15% for most city residents and would eliminate the federal tax obligation for disadvantaged residents. Delegate Norton feels that with these tax breaks, citizens will remain in the District and spend their income here. With the renewed spending, the economy would grow. The 104th Congress adjourned without acting on the DCERA, but it is hoped that the 105th Congress will consider action.

The other option for changing the tax structure would be to allow the District to impose a non-resident tax. A non-resident tax is a tax imposed on suburban residents who work within the District. These residents work in the District but take their income to the surrounding counties without leaving any revenue in the District to pay for the services they use, such as roads and sewers. Approximately 64% of the income earned in the District is earned by non-residents, yet the District has no way to regain those lost revenues. The Appleseed Center estimates that the ban on a non-resident tax cost the District about $471 million in 1995 (CQ Researcher, p. 1040). To impose a non-resident tax at this time may not be politically feasible though. Several members of Congress representing Virginia and Maryland are adamantly opposed to such action since it adversely effects their residents. In addition, many other members actually live outside of the District and do not look kindly on a non resident tax.

Returning Services to the Federal Government

The District is essentially a city-state. It provides many services that are carried out by the state, such as the Medicaid program, a university system, and corrections to name a few. In addition, the District has inherited an unfunded pension liability which as mentioned earlier is approximately $4.7 million. Reformers are adamant that the District cannot continue to fund these services and still remain an economically viable city.

One option widely considered is returning these services to the federal government. Albert "Butch" Hopkins Jr., president of the Anacostia Economic Development Corporation, a nonprofit community development organization believes, "the federal government should serve as the state to the District of Columbia" (CQ Researcher, p. 1041). Returning just the Medicaid program to the federal government would have saved the District of Columbia over $343 million in 1993 alone (Liska et al. Medicaid Expenditures and Beneficiaries, p. 37).

In a June 1996 report, the D.C. Appleseed Center presented three options for reforming the unfunded pension liability: leave the unfunded liability as it presently stands; increase the federal contribution; or "transfer the entire $3.6 billion in net assets currently in the Plans' Retirement Fund as well as the Plan participants and liability from the District to the federal government" (D.C. Appleseed, p. 19). Most reformers agree that the first option, the status quo, is unacceptable and in the long run will leave the city financially crippled. The second option, to increase the federal contribution, would be a great improvement over the present situation. However, the D.C. Appleseed Center feels that in order for the city to get back on its feet, the pension liability should be returned to the federal government. Returning the pensions to the federal government, along with other services will allow the city to concentrate on local activities, rather than state-related services.

Alternatives to the Federal Payment

The federal payment currently amounts to about 15% of the city's $4.5 billion budget. "The percentage is low by historic standards - it stood at 40-50% up to the 1920s - and has been falling since the District's first home rule government took office in 1975" (CQ Researcher, p. 1040). Reformers argue that the federal government needs to increase the amount of annual appropriations. Although the recent elimination of the revenue-related formula was a step in the right direction, the new set payment until 2000 leaves the District with less buying power. A new payment schedule should be devised to ensure the District receives adequate compensation.

Models from Other Cities

The last solution involves studying the actions of other cities' control boards, specifically New York City and Philadelphia.

The New York Financial Control Board (FCB) was created in response to the $1.2 billion operating deficit and $6.2 billion accumulated deficit that New York City faced at the end of fiscal year 1976. In its first year, the FCB:

í Reduced the workforce by 40,000;
* Froze city wages for three years;
* Raised tolls on bridges and tunnels;
* Increased non-resident and subway fares;
* Laid off workers at the municipal hospital;
* Increased taxes and terminated the tuition free policy at City University of New York;
* Overhauled and reformed the city's accounting and budgetary practice, creating an integrated financial management system;
* Secured long term financing in bonds and notes that equated to approximately $3.8 billion.

Through the combined efforts of the control board and New York State officials, New York City was able to balance its budget after six years (GAO/T AIMD-96-133, p. 19-20). The FCB has been in an advisory role since fiscal year 1986, after the city sustained six consecutive years of balanced budgets.

Although New York City is a good model to study, it is important to note several differences between New York City and the District. First, the mayor of New York City and the governor of the state were members of the FCB. The mayor of D.C. is not a member of the control board and some argue has been intentionally left out. Second, New York City was able to lobby for federal assistance in Congress. Although the District can attempt to lobby for additional funding, the District does not have voting representation like New York. Lastly, the state was able to provide additional assistance as needed. The District does not have a state to offer support when federal assistance is lacking. As a result, many of the options available to New York City are not available to the District.

By fiscal year 1992, Philadelphia faced an operating deficit of $98.7 million and an accumulated deficit of $153.5 million. The Pennsylvania Intergovernmental Cooperation Authority was created to help the city resolve its deficit and in its first year:

* Borrowed $475 million in bonds to fund the cumulative deficit, the current year deficit, and subsequent deficits;
* Imposed a 1% sales tax, which resulted in $52.3 million in revenue for FY 1992;
* Renegotiated labor agreements, leading to a 33-month wage freeze;
* Increased collection of back taxes by 10 percent annually;
* Instituted an authority tax of 1.5% on wages, salaries, commissions and other compensation earned by residents of the city.

In addition to the work of the control authority, Philadelphia, in 1992, began updating its financial and information systems. It also began to contract out some custodial work, saving the city an estimated $700,000 annually. After two years, Philadelphia achieved a balanced budget (GAO/T-AIMD-96-133, p. 20-21). Like New York City, Philadelphia had the home state of Pennsylania to provide relief through negotiated changes in payment sharing and other state revenue sources.

Although it may not be politically or financially feasible for the District to immediately institute many of the changes that the cities of Philadelphia and New York City implemented, it is worthwhile to study the accomplishments of these cities and use their expertise to help solve the problems of the District. The District of Columbia is a unique case. It serves as the nation's capital, but also has specific local concerns and priorities as expressed by its residents and elected city government officials. The degree to which the current structure of local and federal relations seriously undercuts the ability of the community to address the current fiscal and economic crisis as well as the long-term health of the city should be seriously considered by all members of the community.
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