Testimony of Ed Lazere, Executive Director, For the Public Oversight Roundtable on The Economic and Financial Impacts of District of Columbia Statehood, District of Columbia Special Committee on Statehood and Self-Determination

Chairman Brown and members of the committees, thank you for the opportunity to speak today.  My name is Ed Lazere, and I am the executive director of the DC Fiscal Policy Institute.  DCFPI engages in research and public education on the fiscal and economic health of the District of Columbia, with a particular emphasis on policies that affect low- and moderate-income residents.  Thank you for the opportunity to testify on this important issue.

Exploring the economic and financial implications of statehood is vitally important.  As other panelists have noted, statehood would likely bring with it new possibilities for raising revenue but also new budget obligations, as well as opportunities to revise our budget procedures.

I would like to focus my comments today by starting with the basic question of whether the District is ready financially to become a state.  I believe the answer is yes.  I also would like to explore some specific ways in which the lack of statehood adversely affects the District – including the very topical issue of using our rainy day fund.

The question that may be lurking behind the subject of today’s roundtable is whether DC is ready – financially – to become a state.   What will happen to us if the federal government cuts the apron strings and leaves us fully on our own?

The answer is not entirely knowable, but I am comfortable that we would be just fine.  The most important factor behind my conclusion is that the District already acts like a state for the most part.  We are responsible for operating and paying for nearly every responsibility that a state or city provides.  For example, we administer a Medicaid program, a transportation program, and a Department of Motor vehicles.  The major DC functions that the federal government operates and pays for are the courts and the felony prison system.  While DC runs its own Medicaid program, the federal share of the costs is higher than the standard federal formulas would dictate, though not the highest in the nation.

Beyond these functions, the District generally does not receive special financial assistance from the federal government.  Most federal funding the District receives comes from federal funding streams for which all states or all cities qualify, such as the Community Development Block grant. There is no blanket “federal payment,” as the city used to receive prior to 1998.  While there is some targeted federal funding for the District, such as the Tuition Assistance Program, it is analogous to the earmarks that members of Congress secure for their districts or states.  As Walter Smith’s testimony points out, professor Garry Young concludes that earmarks to DC likely would grow if we were to become a state.

It also is worth pointing out that the District of Columbia has managed to balance its budget for 11 consecutive years, and we are managing to maintain that balance through the current fiscal crisis.  The District is facing tremendous budget challenges, as is every city and state.  But Mayor Fenty and the DC Council are making the revenue and spending changes needed to keep our budget in balance.  These efforts are totally driven by local officials.

There is a question as to whether the District would receive a net fiscal gain or loss from statehood, but that is hard to answer precisely.  It depends on what federal support we would lose and what additional revenue sources we would gain.  It would be expected that the District would take over court functions and felony prisons – or that it would at least pay for them.  But the District would have a strong case that the 70 percent federal share of Medicaid costs should be maintained, because the share of residents receiving Medicaid is very high.  On the revenue side, it seems reasonable to assume the District would gain the ability to tax non-resident income, as every other state does, but this could come in a variety of forms.

It is possible that the District could see a net financial gain from these changes, but it also could see a net loss.  The large potential revenue gain from taxing non-resident income suggests, however, that a net loss is unlikely – and very unlikely to be substantial.

I now would like to discuss two ways in which I believe statehood would allow the District of Columbia to manage its finances better.  The first involves DC’s rainy day fund – known here as the emergency and contingency reserves.

Like most states, the District of Columbia has a “rainy day” reserve it can use to address a major economic crisis.  The District established the reserve in 2000, following a requirement in that year’s federal appropriations for the city.  The reserve is funded with local revenues only.  But federal restrictions on it make it very difficult for the city to consider using the fund, even in the current economic downturn.

Requiring the District to set up a reserve for a rainy day was a positive step.  It was made, however, at a time when the city still was managed by a federal financial control board, and trust of the city’s ability to manage its finances was low.   As a result, the Congress imposed several rules governing the fund that are far stricter than the rules most states place on their rainy day reserves.  Those rules are making DC leaders reluctant to use our rainy day fund now, in the midst of the worst economic crisis since the Depression.

  • Funds withdrawn from the rainy day fund must be replenished in two years. This means that the District could be forced to repay a withdrawal before its finances have recovered. As a result, officials cannot consider making more than a modest withdrawal from the rainy day fund.

Some 39 of 46 states with a rainy day fund (including DC) have no time-specific replenishment rule.  Most of these 39 states (31) wait to re-build their rainy day funds until their budgets return to surplus; others wait until revenues start growing faster than a specified rate.  Among DC and the six states that require repayment in a certain time frame, only DC and Rhode Island require repayment within two years.

  • Much of the rainy day fund is not available to address revenue shortfalls. DC’s rainy day fund is split into two parts: Some $230 million can be used to address falling revenues. The remaining $100 million is restricted for use in a natural disaster or a declared state of emergency. No other state restricts a portion of their rainy day fund for natural disasters. Instead, most states have full access to their reserves for either a natural disaster or economic downturn.
  • DC’s rainy day fund can be used only if revenues decline dramatically. The fund cannot be used unless a revenue shortfall is greater than five percent of the budget or roughly $250 million. While the District has met that threshold this year, it would have faced budget problems even with a shortfall smaller than this. In 39 states, the rainy day fund can be used whenever revenue collections drop below expected levels by any amount.

I am hopeful that Mayor Fenty and the DC Council can work with Congress to relax these onerous rules and allow DC’s rainy day fund to operate with as much flexibility as funds in the states.  Yet it is problematic that permission must be granted to give the city control over its own resources.

The second issue I would like to discuss is the District’s budget calendar, which is driven largely to satisfy the needs of the federal government because DC’s budget is adopted as part of the federal budget.  DC operates on a fiscal year running from October through September, while nearly every state operates on a July-through-June year which allows the school-year to fully coincide with just one fiscal year.  In addition, DC’s budget is released in March and then must be approved a specified number of days later so that it can be submitted to Congress.  This calendar operates in a way that the District’s key revenue forecast in the spring occurs just before the budget is adopted – or worse, just after.

If the District were not constrained by a Congressional calendar, we could set the budget calendar in a way that final budget decisions would be made after the spring revenue forecast, lessening the likelihood that the budget would need to be changed just after being adopted.

Finally, I would not that fiscal relations between the District and the federal government have improved in recent years.  For example, the District is now able to adopt a supplemental budget without it having to be treated as part of the federal budget, as long as the city’s supplemental is below a certain size.  Prior to that, the District could not be assured that it could adopt a supplemental budget unless a federal supplemental were also adopted.  While this improvement is important, it could be taken away by Congress as easily as it was granted.  It is not something the District controls, highlighting the negative fiscal that the lack of statehood creates.

Thank you for the opportunity to testify.