D.C.'s financial straits.

• Author: Upton, Helen A.
• Position: District of Columbia's financial woes under the Home Rule Act of 1973 - Adapted from Cross Sections, Summer 1996

While the District of Columbia must contend with the same realities that afflict most of the nation's older cities, it has special financial hardships resulting from the terms of the home rule act.

The following article is adapted from the report "DC's Financial Straits," published in Cross Sections, Summer 1996, by the Federal Reserve Bank of Richmond. The views expressed are those of the author and not necessarily those of the Federal Reserve Bank of Richmond or the Federal Reserve System.

As the capital city of one of the richest nations in the world, Washington, D.C., is headquarters for a number of embassies, consulates, political organizations, and trade groups. The city also attracts substantial tourism and even receives an annual payment from the federal government of several hundred million dollars.

The District of Columbia, the official political entity that is Washington, compares favorably with other U.S. cities in many ways. According to a 1994 report by McKinsey & Company, Inc., a management consulting firm, D.C. ranks No. 1 among the 15 largest U.S. metropolitan areas in per-capita income; percentage of residents employed in professional, managerial, and technical jobs; and third in percentage of the population completing college.

But D.C. is a "paradox of financial hardship," in the words of Jim Gibson, a senior associate at the Urban Institute, a nonprofit policy research organization. Despite the city's apparent prosperity and potential, it has had increasingly difficult fiscal problems in recent years. For instance, the city is projecting a $116 million deficit for fiscal year 1996. And the financial control board has submitted the 1997 budget to Congress: a $5 billion budget with a $99.1 million deficit.

D.C.'s growing debt has made it difficult to attract potential investors. In February 1996, Moody's Investors Service Inc. noted that D.C.'s credit rating "may not be low enough for a city that has put forward no credible plan to rescue itself from financial ruin."

Any plan proposed must deal with a variety of issues. On the one hand, the plan must address the same realities that afflict many, if not most, of the nation's older cities. These include an inefficient bureaucracy, the flight of the middle class to the more vital suburbs, and the growing burden of welfare and other support services for many of those left behind.

In addition, a viable plan must deal first with the special hardships resulting from the Home Rule Act of 1973. That legislation severely restricted the city's tax base. It also mandated many services in support of the federal sector. In addition, the city inherited as part of its capital budget a huge and growing pension liability.

The Mixed Blessings of Home Rule

Prior to 1974, the city had no representative government. In extending home rule to the capital city two decades ago, Congress responded to enormous pressure from D.C. residents. City officials believed that home rule would give them the power they needed. "We thought it was an incremental path on which we had embarked," said Walter Fauntroy, D.C.'s delegate from 1971 to 1991. "We wanted budget autonomy, we wanted an automatic federal payment, we wanted the ability to tax [commuters], and we believed that we were on an inevitable progress path that would have resulted in our picking those up as the years unfolded."

Under home rule, the city would be governed by an elected mayor and a city council, but home rule came with many strings attached. Congress retained final control over budgetary matters and the right to legislate for the District at any time. And the President reserved the right to veto any municipal legislation.

While the act did allow the city to levy taxes, Congress severely limited the available tax base. It prohibited the city from taxing the income of nonresident workers, who hold two-thirds of the jobs in D.C. More than half of D.C.'s land - federal property and the property used by foreign embassies and nonprofit organizations - is tax exempt, as are sales in federal areas.

The problem of the narrow tax base was pointed out in "Financing the Nation's Capital," a 1990 report by the independent Commission on Budget and Financial Priorities. Headed by Alice Rivlin, then a senior fellow at the Brookings Institution and now the vice chairman of the Federal Reserve Board, the Rivlin Commission noted that untaxable income earned by nonresidents amounted to about 60 percent of total income earned in the District.

In granting D.C. home rule, Congress also obligated the District to provide public services, such as police, fire, sewer, and water, for the federal government...