What The Fiscal Cliff—Or Slope—Means for Local DC

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Going over the “fiscal cliff” is the talk of Washington right now, but what will stepping over that brink mean for local DC?

The term is shorthand for the payroll and income tax cuts that are set to expire at the end of the year combined with automatic cuts in federal spending that were put into law by Congress during the debt ceiling debate, known as sequestration. Many economists say that the scenario is less a cliff than a slope or hill, because the economic impact likely will not be immediately calamitous. It is more likely to be gradual, and many predict that a compromise will be reached that would stave off more severe consequences such as a recession. Yet the issue is a good reminder that what’s decided within the hallways of Capitol Hill can be felt on the streets of Capitol Hill’as well as Congress Heights, Cleveland Park and Chinatown.

In fact, the folks in DC government who look into the crystal ball and tell us how many dollars we have to spend have been thinking about the impact of the fiscal cliff for some time now. Any policy that broadly influences the size and scope of the federal government will be felt here in DC, since we are the seat of government and many federal workers are located here. A reduction of staff or decrease in federal contracting translates into a reduction in local income taxes, since some residents might lose their jobs, as well as a drop in sales taxes, because residents will have less money to spend, fewer workers will be eating lunches at local restaurants and food trucks, and so on.

This impacts the District’s revenue projections, and how much we can budget for various programs and services. Therefore, it is important that we consider the most likely scenarios and forecast accordingly.

The Federal Factor

There are more than 200,000 federal jobs in the District, according to the U.S. Department of Labor, but only about one in five, or a little more than 45,000, are held by District residents. Yet there are many other jobs that rely on the federal government and federal workers. This would include contractors that do work for federal agencies or companies that supply products for the federal government or even restaurants, dry cleaners or clothing stores that have federal workers as customers.

According to some projections, full sequestration could result in the loss of up to 127,000 DC jobs over the next decade. This number includes 35,000 federal jobs, 34,000 federal contracting and subcontracting jobs, and 58,000 jobs that would be impacted due to the decline in the federal payroll.

Yet there are few who believe full sequestration will happen. Most likely, say many economists and Congressional experts, a compromise will emerge and the automatic reductions will not all take place. Nevertheless, the economists in the revenue analysis division of DC’s Office of the Chief Financial Officer have to make some assumptions about the federal budget and what impact this will have on both the national and regional economy to calculate how much money the city can expect to have in its coffers. CFO Gandhi and his deputies have said that it would be irresponsible not to show an impact from sequestration even if it is not fully implemented. “Despite the recent District job market strength and stronger than expected revenue, the continued uncertainty regarding post-election federal budget actions poses a real risk to the District’s finances,” Gandhi wrote in the September quarterly forecast. He calls the impact of the local cuts and a possible national economic impact a “double-whammy” for the District.

Economic indicators continue to show that the District is on the rise. Income and sales taxes remain strong and growing. Yet this was not reflected in an uptick projected future revenues in September’s revenue forecast because Gandhi said there was too much uncertainty about the fiscal cliff and how Congress would handle it. The murkiness led Gandhi to be cautious, and therefore despite strong revenue trends, the CFO declined to make any new projections for tax collections in 2013 and beyond.

Yet, the CFO wrote, if the fiscal cliff is largely avoided, “the revenue picture for the District would improve significantly” from what the CFO projected in his September revenue forecast.

Why The Cliff is Not a Cliff

Economists like Mark Zandi of Moody’s Analytics say that the most likely scenario is that the fiscal cliff will be avoided, and that a budget deal will likely keep many of the tax cuts in place and avert the automatic spending cuts, while coming up with another long-term plan for reducing spending. Therefore, the fiscal cliff is really not a cliff.

Thus, it seems likely that there will be some impact on economic growth, but DC will not end up seeing huge federal workforce cutbacks right away.  This is very important, because it means that the impact on income and sales tax revenues will not likely be as severe as the CFO has projected. It also means that the city’s leaders will have a number of years to adjust to the downsizing of the federal government.

And this has a very direct impact on how the District can allocate its resources this budget year.

Once the specter of the fiscal cliff is lifted, the revenue forecast likely will show we have more money right now. That would almost certainly mean that Gandhi and his fellow economists would project an uptick in revenue in the December forecast.

In most years, the September and December revenue forecasts would not be a major issue, since the most important forecast for the budget is issued in February.  But for this year’s budget, the Mayor and DC Council anticipated that revenues might rise, factored that into its budget plan, and created a contingency budget on how to spend those dollars.  For example, the approved homeless services budget is $7 million shy of what is needed just to maintain current services.  That means that choosing not to adjust the 2013 forecast until February or later could mean that many basic services will go unfunded.

Revenue Forecasting With and Without The Cliff

Revenue forecasting is not an exact science. Economists use economic data to make assumptions about what will happen, but it is worth making sure those assumptions are based on the most likely scenarios. Given that most economists believe that the cliff will be averted and sequestration will likely not take effect, our city’s revenues should reflect those likely assumptions.

For that reason, we’re hopeful that the next revenue forecast reflects the expectation that the fiscal cliff will likely be avoided. But the CFO may feel the need to be cautious until a federal budget deal is fully worked out, which may not occur before the next DC revenue forecast is due. One idea would be for the next revenue forecast in December to reflect revenues if the fiscal cliff should occur’as well as if it should not.

There are several advantages to this approach. First, it will make the calculated impact of the federal cliff scenario more transparent. And the Mayor and DC Council would have an idea of what revenues might be available if a compromise happens.

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