DC’S Fund Balance Remains Larger Than Most States: Current Proposals to Rebuild DC’s Reserves May Overly Restrict DC’s Ability to Respond to Ongoing Budget Needs

DC’s fund balance ‘ essentially the city’s savings account ‘ has declined in recent years, after rising in the early 2000s.  This has raised concerns among policymakers and has spurred new proposals in the FY 2011 budget to replenish the fund balance.   But the level of concern ‘ including speculation that DC’s current fiscal practices could lead to the return of the federal control board ‘ is exaggerated.  Most states have drawn down their fund balance in response to the recent recession, which has been one of the worst on record.  Despite substantial use of the fund balance over the past five years, DC’s fund balance at the end of 2011 will be larger than in 43 states.

Moreover, DC’s use of its fund balance in recent years in many cases reflected conscious decisions to use surpluses that had built up unexpectedly.  The District utilized a substantial portion of its fund balance to pay directly for capital improvement projects rather than borrowing for them, as well as to address a change in government accounting standards that requires the city to set aside large payments for health benefits for DC government retirees.  In the current recession, DC has used a portion of its fund balance to prevent severe cuts to city services.  Much of the recent use of fund balance comes from a number of “special purpose” funds that were underutilized and had built up large surpluses.

The FY 2011 budget includes a proposal to set aside 100 percent of future surpluses — about $530 million — in a new “cash flow reserve.”   While the District is moving in the right direction by working to replenish the fund balance, the questions of when to do so and how much, need to be carefully considered.  The proposal to designate all year-end surpluses for the cash flow reserve is concerning, especially at a time when city finances are still fragile, because the fund would likely not be available to address fiscal problems.  Also, the proposal would build DC’s reserves to a level that is higher than the city’s peak fund balance in 2005 — and to the upper limits recommended by the National Association of Government Finance Officers.  This could restrict the city’s ability to respond to ongoing budget needs.

In addition, the budget includes a proposal to use surpluses to create an operating budget reserve of about $120 million for unforeseen spending pressures.  While such a reserve makes sense, it would not be funded until after the $530 million cash flow reserve is fully funded ‘  which would take years ‘  and it  would be larger than the $50 million reserve included in DC’s budget in recent years.  Perhaps most important, a large operating reserve could create disincentives to address spending pressures through budget savings.

Both of these proposals should be modified.  In particular:

  • The District should designate a portion of surpluses’ such as 50 percent ‘for these reserves, but not 100 percent.  This is important because it would leave some funds available for unanticipated problems.  Any rule that is set now will be hard to change, because loosening a proposal to build up the fund balance may be seen as fiscally irresponsible.
  • The fund balance should be built up to give the city one month of “working capital,” as recommended by government finance experts.  This would mean setting aside about $143 million, rather than $530 million, in addition to the current six percent rainy day reserves.
  • The operating cash reserve should be set at a lower amount — such as $50 million ‘ and it should be funded before the cash flow fund is filled.  This is important to ensuring that the city has flexible funds to address unforeseen fiscal problems.

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