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Testimony: 

Before the Subcommittee on the District of Columbia, Committee on 
Appropriations, U.S. Senate:

For Release on Delivery Expected at 10 a.m. EDT Tuesday, June 22, 2004:

DISTRICT OF COLUMBIA:

Structural Imbalance And Management Issues:

Statement of Patricia A. Dalton, Director, Strategic Issues:

GAO-04-908T:

GAO Highlights:

Highlights of GAO-04-908T, testimony before the Subcommittee on the 
District of Columbia, Committee on Appropriations, U. S. Senate 


Why GAO Did This Study:

District of Columbia officials have reported both a current services 
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 governmentís presence and restrictions 
on the Districtís tax base. Accordingly, at various times District 
officials have asked the Congress for additional funds and other 
measures to enhance revenues. In that context, the Subcommittee has 
asked GAO to discuss its May 2003 report, District of Columbia: 
Structural Imbalance and Management Issues (GAO-03-666). This 
testimony addresses the key findings and concluding observations of the 
May 2003 report. Specifically, this testimony discusses: (1) whether, 
or to what extent, the District faces a structural imbalance between 
its revenue capacity and the cost of providing residents with average 
levels of public services by using a representative services approach; 
(2) any significant constraints on the Districtís revenue capacity; (3) 
cost conditions and management problems in key program areas; and (4) 
the effects of the Districtís fiscal situation on its ability to fund 
infrastructure projects and repay related debt.

What GAO Found:

GAO used a multifaceted approach to measure structural imbalance, 
which involves comparing a fiscal systemís ability 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 Districtís circumstances to a benchmark based on 
the average spending and tax policies of the 50 state fiscal systems 
(each state and its local governments). GAO also reviewed key programs 
as well as infrastructure and outstanding debt. GAO found:

* 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 Districtís 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 Districtís structural 
deficit, though it likely exceeds $470 million annually. Consequently, 
even though the Districtís 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 Districtís significant, long-standing 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 Districtís underlying structural imbalance because this 
imbalance is determined by factors beyond the Districtís direct 
control. 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. 

If this imbalance is to be addressed in the near term, it is a policy 
issue for the Congress to determine if it should change federal 
policies to expand the Districtís tax base or provide additional 
support. However, given the existence of structural imbalances in 
other jurisdictions and the Districtís significant management problems 
and the federal governmentís own fiscal challenges, federal 
policymakers face difficult choices regarding what changes, if any, 
they should make in their financial relationship with the District. If 
the District were to receive additional federal support to compensate 
for its structural imbalance and enhance its ability to fund capital 
investments, it is important that the District follow sound practices 
to avoid the costly management inefficiencies it has experienced in 
the past. These practices include evaluating and selecting capital 
assets using an investment approach, integrating organizational goals 
into the capital decision-making process, and providing transparency 
and accountability over the use of federal funds.

www.gao.gov/cgi-bin/getrpt?GAO-04-908T

To view the full product, click on the link above. For more 
information, contact Patricia A. Dalton at (202) 512-6806 or 
daltonp@gao.gov.

[End of section]

Mr. Chairman and Members of the Subcommittee:

I am pleased to be here today to discuss our report, District of 
Columbia: Structural Imbalance and Management Issues.[Footnote 1] 
Though our report was released a year ago, its focus on fundamental 
aspects of the District's financial structure continues to be relevant. 
In recent years, District of Columbia (District) officials have 
reported that a continuation of the District's current spending and 
taxing policies would result in ongoing current services budget 
imbalances. While District officials have demonstrated their resolve to 
maintain fiscal discipline by taking the steps needed to balance their 
budgets for fiscal years 2004 and 2005, those officials claim that the 
District faces a more permanent structural imbalance between its 
revenue-raising capacity and the cost of meeting its public service 
responsibilities that are the result of many factors, several stemming 
from the federal government's presence in the District and the 
restrictions on the District's tax base.

Although there is no uniform definition of structural imbalance, there 
are two concepts that can be used to measure it--current services and 
representative services imbalances. A current services imbalance 
answers the question: If a jurisdiction were to maintain its current 
level of services into the future, would it be able to raise the 
revenues necessary to maintain that level of service under its current 
taxing policies? This type of longitudinal analysis compares a 
jurisdiction's projected fiscal position with its current position and 
is independent of other similarly situated jurisdictions. In contrast, 
a representative services imbalance answers the question: If a 
jurisdiction were to provide a representative basket of public services 
with average efficiency, would it be able to generate sufficient 
revenues from its own taxable resources and federal grants to fund the 
representative basket of services if its resources were taxed at 
representative rates? This type of analysis uses a basket of services 
and tax structure typical of other jurisdictions with similar public 
service responsibilities as a benchmark against which to compare 
imbalances between the cost of public services and revenue-raising 
capacity. The approach attempts to compare differences in 
jurisdictions' fiscal positions under a common set of policies 
regarding levels of services and taxation. The District has reported 
both a current services and a more permanent structural imbalance 
between its costs and revenue-raising capacity.

My statement today will discuss (1) whether, and 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 by using a representative services approach; (2) any 
significant constraints on the District's revenue capacity; (3) cost 
conditions and management problems in key program areas; and (4) the 
effects of the District's fiscal situation on its ability to fund 
infrastructure projects and repay related debt.[Footnote 2] We 
performed our work assessing the structural imbalance and management 
issues from August 2002 through May 2003 in accordance with generally 
accepted government auditing standards, and in June 2004 we obtained 
updated budget information.

GAO's Methodology for Assessing Structural Imbalance:

We used a representative services analysis to conduct our work on 
whether and to what extent the District has a structural imbalance. 
This approach allows us to compare the District's fiscal circumstances 
against a benchmark based on services and taxation that is typical of 
jurisdictions with similar fiscal responsibilities, which is different 
from a current services approach, which would be based on the 
District's historical spending and tax choices.

When analyzing a representative service imbalance, the choice of a 
benchmark for a representative level of public services and taxation is 
a critical decision. In fact, the appropriate level of services and 
taxation is a matter of perennial debate in every jurisdiction in the 
nation. For this reason, we used as a benchmark national average levels 
of spending and taxation because they are independent of individual 
jurisdictions' particular preferences, policy choices, and efficiency 
of service provision. National averages provide benchmarks that are 
"representative" of the level of services that a typical state fiscal 
system (the collections of a state, counties, cities, and a myriad of 
special purpose district governments) employs. A fiscal system is said 
to have a structural imbalance if it is unable to finance an average 
(or representative) level of services by taxing its funding capacity at 
average (or representative) rates. Because we defined structural 
imbalance in terms of comparisons to national averages, for any given 
time period a significant proportion of all fiscal systems will have 
structural deficits.

Determining empirically whether the District has a structural imbalance 
is a complex task that involves making judgments about: (1) the 
appropriate set of governments to use when developing benchmarks for 
the District's spending and revenue capacity; (2) the influence that 
various workload and cost factors, such as the number of school age 
children and number of vehicle miles traveled, have on the cost of 
public services; and (3) the best way to measure revenue capacity.

Using economic modeling, we were unable to provide a single, precise 
point estimate of structural imbalance, but provided a range instead. 
Given the lack of professional consensus and a limited empirical basis 
for many of the decisions underlying our methodology, which was vetted 
with key experts, we performed several sensitivity analyses to show how 
our estimates changed as we varied key assumptions. In addition, the 
precision of our estimates is adversely affected by data limitations 
for various cost and tax bases. Nevertheless, we believe that the 
consistency of our basic result over a broad range of alternative 
assumptions and approaches provides sufficient support for the 
conclusions offered in this report. Moreover, we supplemented our 
quantitative analysis with a programmatic review of the District's 
three highest cost program areas to provide additional insights into 
the level of services, costs, management, and financing.

For our cost analysis, we computed two separate sets of benchmarks: one 
based on a "state" services basket, the mix of services typically 
provided by state fiscal systems (each state and all of its local 
governments), and a second based on an "urban" services basket, the mix 
of services that are typically provided by governments in more densely 
populated areas. The scope of services included is the same for both 
baskets; what differs is the proportion of total spending that is 
allocated to each service. For example, the "urban" basket of services 
gives greater weight to public safety functions and less weight to 
higher education than does the state basket of services.

To estimate total revenue capacity of each state fiscal system, we 
combined estimates for the two principal sources from which those 
systems finance their expenditures: (1) revenues that could be raised 
from each system's own economic base (own-source revenue), and (2) the 
federal grants that each system would receive if it provided an average 
basket of services. Two basic methodologies have been employed to 
estimate the own-source revenue capacity of states: (1) the total 
taxable resources (TTR), which uses income to measure the ability of 
governments to fund public services; and (2) the representative tax 
system (RTS), which measures the amount of revenue that could be raised 
in each state if an average set of tax rates were applied to a 
specified set of statutory tax bases "typically" used to fund public 
services. Because experts disagree as to which approach is superior, we 
computed separate results using both methodologies.

We estimated the size of the District's structural imbalance as the 
difference between its cost of providing an average level of services 
and its total revenue capacity--the amount of revenue the District 
would have (including federal grants) if it applied average tax rates 
to its taxable resources.

The District's Public Service Costs Are the Highest in the Nation:

Using other state fiscal systems as a benchmark, our analysis indicated 
that the cost of delivering an average level of services per capita in 
the District exceeds that of the average state fiscal system by 
approximately 75 percent (or a total of $2.3 billion more annually than 
if it faced average costs circumstances) and is over a third more than 
the second highest-cost state system, New York. If state fiscal systems 
were to provide a basket of services typically provided in more densely 
populated urban areas, we estimated that the District would have to 
spend over 85 percent more (or a total of $2.6 billion more annually) 
than average to fund an average level of services.

The District faces high-cost circumstances, largely beyond its control, 
in key program areas including Medicaid, elementary and secondary 
education, and police and fire services that increase the fiscal 
burdens on the District's budget. For example, regarding Medicaid, we 
estimated that high-cost circumstances, such as its large low-income 
population, would require the District to spend well over twice the 
national average per capita. Consequently, to provide an average level 
of services the District would have to spend a total of $437 million 
more than if it faced average cost circumstances. Similarly, we 
estimated that the District's per capita cost of elementary and 
secondary education is 18 percent above the average state fiscal system 
due to circumstances such as a disproportionately high percentage of 
low-income children. As a result, to provide an average level of 
services the District would have to spend a total of about $136 million 
more than if it faced average cost circumstances. Likewise, for police 
and fire services, the District's per capita costs of providing an 
average level of services are well over twice the national average due 
to circumstances such as its relatively young population, especially 
high crime rates, and its dense living conditions. As a result, to 
provide an average level of services the District would have to spend 
about $480 million more than if it faced average cost circumstances. 
Further, our cost estimates do not explicitly account for the various 
public safety demands and costs associated with the federal 
government's presence.

The District's Revenue Capacity Is Among the Highest in the Nation, 
Despite Some Constraints on Its Taxing Authority:

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. Its capacity is high even though the District 
faces some significant constraints on its taxing authority, such as the 
inability to tax federal property or the income of nonresidents who 
work in the District.

The two estimation approaches we used to measure the District's revenue 
capacity 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. This high own-source revenue 
capacity, combined with the fact that its per capita federal grant 
funding is over two and one-half times the national average, gives it a 
higher total revenue capacity than any other state fiscal system. 
Depending on which estimation approach we used, the District's total 
revenue capacity ranged from 47 percent above the national average 
(based on a conservative version of the RTS approach) to 60 percent 
above (based on the TTR approach).

The District Faces a Structural Deficit:

We concluded that the District does have a substantial structural 
deficit in the sense that the cost of providing an average level of 
public services exceeds the amount of revenue it could raise by 
applying average tax rates, although considerable uncertainty exists 
regarding its exact size. We obtained our lowest deficit estimate of 
about $470 million per year by combining the lowest estimate of the 
District's costs (the one based on the state basket of services) with 
the highest estimate of the District's total revenue capacity (TTR). In 
contrast, we obtained the highest deficit estimate of over $1.1 billion 
per year by combining the highest estimate of the District's costs (the 
one based on the urban basket of services) with the lowest estimate of 
the District's total revenue capacity (RTS). Among the contributing 
factors to the structural imbalance are high-cost conditions largely 
beyond the District's control, such as high poverty rates, large 
concentrations of low-income children and the elderly, and high crime 
rates. Figure 1 shows how the District's structural deficit per capita 
compares to the state fiscal systems with the largest structural 
deficits.

Figure 1: Fiscal Systems with the Largest Structural Deficits Per 
Capita:

[See PDF for image]

[End of figure]

Despite a High Tax Burden, the District's Revenues Are Only Sufficient 
to Fund an Average Level of Services:

In addition to having high revenue capacity, the District also imposes 
above average tax rates; however, high taxes are only sufficient to 
fund an average level of services. Figure 2 shows the District's tax 
burden and cost-adjusted spending. Because of its high tax rates, 
actual revenues collected by the District exceeded our lower estimate 
of its own-source revenue capacity at an average tax burden by 33 
percent and exceeded our higher estimate of that capacity by 18 percent 
(see the first two bars of fig. 2). However, the District's actual 
fiscal year 2000 spending was only equal to the cost of an average 
level of public services, based on the basket of services provided by 
the average state fiscal system. Using the basket of services typically 
provided by urban governments as a benchmark, the District's spending 
is 5 percent below that needed to fund an average level of services 
(see the last two bars of fig. 2). Our estimates of the cost of 
delivering an average level of services presume that they are provided 
with average efficiency. To the extent that the District does not 
deliver services with average efficiency, its actual level of services 
may be below average.

Figure 2: District's Tax Burden and Cost-adjusted Spending:

[See PDF for image]

[End of figure]

Management Problems Result in Unnecessary Spending That Compromises the 
District's Ability to Provide an Average Level of Public Services.

The District's long-standing management problems waste resources that 
it cannot afford to lose and draw resources away from providing even an 
average level of services. In three key program areas (Medicaid, 
elementary and secondary education, and police and fire services), our 
original report identified significant management problems, such as 
inadequate financial management, billing systems, and internal 
controls. While the District has taken some actions to correct 
management inefficiencies, more improvements are needed. In the case of 
Medicaid, in fiscal year 2001 the District wrote off over $78 million 
for several years worth of unreimbursed claims for federal Medicaid 
matching funds. The District was not able to claim this reimbursement 
because of late submission of reimbursement requests, incomplete 
documentation, inadequate computerized billing systems, providing 
services to individuals not eligible for Medicaid at the time of 
delivery, and billing for services not allowable under Medicaid. The 
independent auditor of the District's financial statements continued to 
report Medicaid accounting and claims processing as a material weakness 
in fiscal year 2003. The extent of these management problems suggests 
that the District continues to bear more of the burden of Medicaid 
costs than necessary.

In the case of education, in the recent past District public school 
officials were not able to track either the total number of employees 
or whether particular positions were still available or had been 
filled. For example, in March 2003, District officials announced that 
the school system had hired 640 more employees than its budget 
authorized, resulting in the District exceeding its personnel budget by 
a projected amount of $31.5 million over the entire fiscal year. In 
another example, the District's lack of internal control for 
procurement practices in its public school system resulted in $10 
million in unauthorized purchases. While our cost analysis shows that 
the District is spending an amount that could provide an average level 
of services, the extent of these management problems suggests that the 
District provides less than the national average of education services.

In the case of police and fire services, the District historically has 
not adequately tracked the costs it incurs to support the federal 
presence, in areas such as providing protection to federal officials 
and key dignitaries and dealing with an array of special events and 
demonstrations. This hinders its ability to make a case for additional 
federal reimbursement, requiring it to spend more of its own resources 
to support the federal presence.

The District Continues to Defer Improvements to Its Infrastructure 
While Debt Pressures Remain:

Although the District is making some attempts to address its backlog of 
infrastructure needs, it has nonetheless continued to defer significant 
amounts of infrastructure projects because of constraints in its 
operating budget. Most of the District's infrastructure and capital 
improvement projects are financed by using general obligation bonds. 
The interest and principal payments (debt service) on those bonds are 
paid from the District's operating budget. Although the District is not 
close to its legal debt limit, it cannot accommodate additional debt 
without cutting services or raising taxes that are already higher than 
those of other jurisdictions. Contributing to the District's 
difficulties is its legacy of deteriorated infrastructure and its 40 
percent share of funding the metropolitan area's costly mass transit 
system. However, the District is attempting to address its backlog of 
infrastructure needs through increased capital expenditures (estimated 
at roughly $371 million in fiscal year 2003). Nevertheless, the reality 
is that the District continues to defer major infrastructure and 
capital investment in part because of its structural imbalance.

From 1995 to 2002, the District's outstanding general obligation debt 
changed little, totaling slightly over $2.67 billion as of September 
30, 2002, and debt per capita has remained fairly constant. The 
District's total outstanding general obligation debt as of September 
30, 2003, was $3.25 billion. As a percentage of local general fund 
revenues, debt service costs, which were 7.5 percent of revenue for 
fiscal year 2003, are expected to climb to approximately 10 percent by 
2006. The District's projections assume that debt service costs will 
increase at a higher rate than local revenues. Furthermore, when 
compared to combined state and local debt across the 50 states, the 
District's debt, both per capita and as a percentage of own-source 
revenue, ranks among the highest in the nation. Despite the challenges 
it faces, the District has been successful in having its bond rating 
upgraded by all the major rating agencies in part due to the improving 
economy and improved financial management.

Concluding Observations:

Due to a combination of its substantial structural deficit and 
significant management problems, the District is likely providing a 
below-average level of services even though its tax burden is among the 
highest in the nation. By addressing its management problems, in the 
long term the District could reduce future budget shortfalls. However, 
management improvements will not offset the underlying structural 
imbalance because it is caused by factors beyond the direct control of 
District officials. As a consequence, District officials may face more 
difficult policy choices than most other jurisdictions in addressing a 
budget gap between spending and revenues based on current policies. 
Since the District may not be providing an average level of services, 
it would also be difficult to cut services further and the tax burden 
it imposes is among the highest in the nation. An alternative option to 
raising taxes or cutting services would be for District officials to 
continue deferring improvements to its capital infrastructure. This 
strategy also is not viable in the long run in that deteriorating 
infrastructure would of necessity lead to further reductions in the 
levels and types of services provided and ultimately would necessitate 
either higher taxes or cuts in services.

Although it would be difficult, District officials could address a 
budget gap by taking actions such as cutting spending, raising taxes, 
and improving management inefficiencies. However, a structural 
imbalance is beyond the direct control of local officials. Without 
changes in the underlying factors driving expenses and revenue 
capacity, the structural imbalance will remain. 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. Further, another consideration for the 
Congress is that the federal government faces its own long-term fiscal 
challenges with the prospect of large, persistent deficits. 
Nevertheless, by virtue of the District being the nation's capital, 
justification may exist for a greater role by the federal government to 
help the District maintain fiscal balance. At the same time, the 
District must achieve basic management performance and accountability 
standards to ensure an efficient use of any resources.

Accordingly, if the District were to receive additional federal 
assistance to compensate for its structural imbalance and enhance its 
ability to fund capital investments--as is proposed in the District of 
Columbia Fair Federal Compensation Act of 2004 (H.R. 4269)--it is 
important that the District follow sound practices in order to avoid 
the costly management inefficiencies it has experienced in the past. 
The Congress needs assurance that any federal assistance to the 
District would be spent effectively and efficiently. It is critical to 
have clear, transparent reporting and accountability mechanisms in 
place to ensure the proper use of federal funds. Also, the Congress 
might want to consider incentives to encourage the effective 
utilization of any federal funds.

Specifically, we have issued detailed guidance--based on best practices 
of public and private entities--for the planning, budgeting, 
acquisition, and management of capital assets, including infrastructure 
projects and technology upgrades.[Footnote 3] Key elements of this 
guidance are to closely link any planned capital investments to a 
government or agency's strategic goals and objectives, ensure that 
effective information systems are in place to support sound decision 
making and management, and for city leaders to clearly communicate 
their vision and goals to project managers. In addition, our past work 
has shown that it is useful to make capital decisions based on the 
following five basic principles and to follow related practices.

* Integrate organizational goals into the capital decision-making 
process, such as conducting comprehensive assessments of needs in 
relation to the current inventory of assets, and evaluating alternative 
approaches to meeting needs.

* Evaluate and select capital assets using an investment approach, 
meaning that a clear project approval framework should be established, 
projects should be ranked based on established criteria, and long-term 
capital plans should be developed.

* Balance budgetary control and managerial flexibility when funding 
capital projects, which entails budgeting for the projects in segments 
and considering full, upfront funding.

* Use project management techniques to optimize project success, such 
as monitoring project performance, establishing incentives for 
accountability, and using cross-functional teams to manage the 
projects.

* Evaluate results to make sure goals and objectives are being met and 
incorporate lessons learned into the decision-making process, including 
occasional reappraisals of decision-making and management processes.

We have not examined the District's capital planning and management 
functions. District officials may already be following these principles 
and practices. Nevertheless, all of them are important to consider in 
order to maximize investment.

Mr. Chairman, this concludes my prepared statement. I would be pleased 
to answer any questions you or the other members of the Subcommittee 
may have at this time.

For future contacts regarding this testimony, please call Patricia A. 
Dalton, Director, Strategic Issues, at (202) 512-6806. Other 
individuals who made key contributions to this testimony were Thomas 
Yatsco, Eric Mader, Jeanette Franzel, Norma Samuel, Ann Calvaresi Barr, 
Jerry Fastrup, and James Wozny.

(450337):

FOOTNOTES

[1] U.S. General Accounting Office, District of Columbia: Structural 
Imbalance and Management Issues, GAO-03-666 (Washington, D.C.: May 
2003). 

[2] Prior to our May 2003 report, we issued a preliminary report on 
these issues in September 2002. See U.S. General Accounting Office, 
District of Columbia: Fiscal Structural Balance Issues, GAO-02-1001 
(Washington, D.C.: September 2002).

[3] U.S. General Accounting Office, Executive Guide: Leading Practices 
in Capital Decision-Making GAO/AIMD-99-32 (Washington, D.C.: December 
1998).