The Challenges of Plenty in Washington, D.C.

Alice M. Rivlin
Alice Rivlin
Alice M. Rivlin Former Brookings Expert

August 14, 2005

Only 10 years ago, the District of Columbia was staring bankruptcy in the face. It was borrowing short-term just to pay routine bills, its operating fund was half a billion dollars in the hole, and its bond rating could only charitably be called “junk.” Today, D.C. is flush. It has a $1.2 billion reserve fund, a surplus in the range of $300 million and that most politically hazardous of commodities—choices.

What to do with this unexpected windfall? That question poses a challenge to the wisdom and courage of the city’s elected officials. It is an opportunity to do visible good for D.C. citizens—to add needed services or give some relief to hard-pressed taxpayers—but it is also risky. That’s because the primary source of the surplus is the city’s remarkable housing boom. And if the real estate boom that’s driving housing prices sky-high is really a bubble, it could burst at any time. Then cuts in taxes or major new spending programs could plunge the District back into its all-too-familiar position of fiscal distress.

Deficits make it easier for politicians to act responsibly because they provide political cover for turning down requests for spending increases and tax cuts. When the deficit becomes a surplus, politicians are deprived of any obvious reasons for fiscal prudence. Just look at the federal government; it faced the “surplus problem” in 2000-01 and flunked the test. Spending, which grew slowly through the deficit reduction years of the 1990s, surged as soon as the surpluses appeared and Congress eagerly joined the president in slashing tax rates. With the added impact of war and recession, the surpluses simply vanished. Now we face the prospect that continuing federal deficits will become unsustainable as the Baby Boom generation retires. The District needs a better role model than its supposed fiscal masters at the federal level.

The city needs to remember what the federal government forgot: Windfalls can vanish with a change of season. That’s why it’s best for D.C. to live by two simple rules: 1) Limit ongoing commitments that will weigh down the city if excess revenues disappear. 2) Help those who are suffering, rather than benefiting, from the boom.

Being awash in cash isn’t a situation the District is accustomed to, but in the past decade a combination of good management and good luck turned the city’s fiscal fortunes around. Part of the good management credit goes to the federally appointed “control board” under the leadership of Andrew Brimmer (whom I later succeeded); part belongs to the financial skills of Mayor Anthony Williams and Natwar Gandhi in the much-needed new position of independent chief financial officer; and part goes to the federal government for taking over some statelike functions (such as moving the District’s convicted felons into federal prisons), albeit at the price of ending the annual federal payment. New city officials have also modernized many of the District’s notoriously creaky administrative systems.

The good luck is that the District is at the center of a thriving regional economy and is finally sharing in the area’s exuberant prosperity. The revitalization of downtown and the revival of tourism since 9/11 have swelled retail sales. Federal growth related to defense and homeland security has boosted jobs and income. New demand for housing in the city has spurred home building and renovation. Residential property values have skyrocketed—and taken property tax revenues up with them—even in the less affluent parts of the city. The result is that the District, which had a surplus of $318 million in fiscal year 2004, will probably end fiscal year 2005 with a surplus in the same range, and move into the next year with expectations of more positive revenue surges.

The downside of the city’s positive transformation is the effect on the low- and moderate income population, which is facing rapidly rising housing costs unmatched by increases in income. The District, which is home to a disproportionate number of the region’s poor, has concentrated pockets of poverty, especially east of the Anacostia River and in parts of Northeast, that have not shared in the new prosperity. For elderly and disabled residents, and those without the skills to move up a career ladder, the housing boom means rising rents and real estate taxes for low-quality housing.

Moreover, despite the fiscal good news in the operating budget, the city still bears a heavy burden carried over from the bad old days. Decades of failure to maintain the city’s crumbling school buildings and other infrastructure have left a legacy of neglect that will take years to fix. The aging Metro system is in urgent need of modernization and more funding. The District’s debt per capita is high, although rapid improvement in the city’s bond rating has made debt service less expensive. Moreover, recent prosperity does not alter the fact—well-documented by the Government Accountability Office—that the District’s underlying fiscal structure is unsound, posing the risk of future deficits again. The steep costs of delivering public services in central cities, high poverty rates and federal restrictions on taxation, especially on nonresident income, combine to make it impossible for the nation’s capital to provide average public services at average tax rates.

The structural deficit—combined with the legacy of past neglect—creates a powerful rationale for additional federal help to the District. D.C. Del. Eleanor Holmes Norton (D), with the co-sponsorship of our area’s entire congressional delegation, has proposed legislation to create an $800 million annual contribution from the federal government to the District to fund debt service and the modernization of the city’s schools, transportation and information technology infrastructure. This fund, essentially a revival of the now-defunct federal payment but targeted to infrastructure, would help transform Washington from a city of antiquated, dysfunctional facilities to a modern, efficient capital that the whole country could be proud of. But given the disarray in the federal budget, Washington residents shouldn’t hold their breath waiting for federal help.

So far, District officials have done reasonably well on all scores. While all the city’s politicians had new spending proposals this year, those that made it into the fiscal 2006 budget sent to Congress featured training programs, child care to help working people with low incomes, and investment in neglected neighborhoods. Some D.C. Council members favored major tax reductions, but caution prevailed. The tax cuts enacted were modest, mostly directed toward the low end of the income scale, and contingent on the chief financial officer certifying projections of a five-year balanced budget. Hey, Congress, there’s a good idea! You, too, could condition future tax cuts on the nation’s ability to afford them.

If the city’s surging revenues continue into the next fiscal year, the District could satisfy both criteria at once by channeling a portion of the boost in residential property tax receipts into the Housing Production Trust Fund, which the city created in 1988 to support affordable housing but which only recently received any money. The fund can work, especially in mixed income neighborhoods, by sharing the cost of land, providing loans and making grants to lower the cost of a housing project along with the project’s rents or sales prices. This investment at the front end of a project avoids a commitment to annual subsidies that might not be sustainable if the housing bubble burst. But it would make it possible for the city to accelerate its efforts to preserve and enhance affordable housing and to create more vibrant places for people of all income levels to live.