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Natwar M. Gandhi, Deputy Chief Financial Officer of Tax and Revenue
Earl C. Cabbell, Interim Chief Financial Officer
Testimony to the Council Committee on Finance and Revenue
April 26, 1999

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District of Columbia City Council Hearing
Committee on Finance and Revenue

Bill 13-132, Tax Reduction Amendment Act of 1999
Bill 13-161, Service Improvement Act of 1999, Title VIII:
Business Tax Restructuring and Incentive Amendment Act of 1999
Bill 13-193, Tax Parity Act of 1999
Bill 13-194, Real Property Tax Classes & Tax Rates Amendment Act of 1999

Monday, April 26, 1999
10:00 A.M.

Council Chambers, One Judiciary Square

Before
Committee on Finance and Revenue
Councilmember Jack Evans, Chair
Council of the District of Columbia

Testimony of Natwar M. Gandhi
Deputy Chief Financial Officer for Tax and Revenue

Earl C. Cabbell, Interim Chief Financial Officer
District of Columbia

Good morning, Chairman Evans and members of the Committee. My name is Natwar M. Gandhi and I am the Deputy Chief Financial Officer for Tax and Revenue. I am here today to testify on several tax bills including:

  • The Tax Reduction Amendment Act of 1999 (the Schwartz Plan);
  • The Service Improvement Act of 1999, also known as the Business Tax Restructuring and Incentive Amendment Act of 1999 (the Mayor's Plan);
  • The Tax Parity Act of 1999 (the Evans/Catania Plan); and,
  • The Real Property Tax Classes and Tax Rates Amendment Act of 1999 (the Orange Plan)

I would like to preface my testimony by stating that the Office of the Chief Financial Officer (OCFO) supports tax restructuring and tax relief. Over the last two years we have advocated tax reform and are pleased that discussion is now underway to effect meaningful change. However, reform must be built on a strong base. Because our tax system does not fit the economy, D.C.'s revenue growth does not keep pace with overall economic growth. In the long term, successful tax reduction must be coupled with broadening the inadequate tax base.

The current tax structure does not tax the growing segments of the economy while it overburdens the remaining segments. Coupling this with the District's narrow tax base results in tax burdens that are significantly higher than those of the surrounding jurisdictions. To be competitive with other jurisdictions for the taxed segment of our economy will require a reduction of our tax burdens. The OCFO supports tax reform consistent with the District's long range financial plan.

Let me briefly summarize the main provisions of these bills and then discuss their probable fiscal impact on the District's budget.

Summary of Proposals and their Revenue Cost

The Schwartz Plan, the Tax Reduction Amendment Act of 1999, proposes the following:

  • reduce the general sales and use tax rate from 5.75% to 5.0%,
  • eliminate sales tax on clothing items priced $100 or less,
  • lower the individual income tax rates from 9.5% to 7.5%; and,
  • eliminate the professional license fee.

The cumulative, FY 2000 – FY 2003, four-year revenue cost of this plan is $634.3 million (See Table on Page 9).

The Mayor's Plan, The Business Tax Restructuring and Incentive Amendment Act of 1999 would:

  • establish filing thresholds for the franchise tax, the arena fee, and the personal property tax;
  • change the net operating loss deduction and eliminate carryback of losses;
  • eliminate the professional license fee;
  • reduce the commercial real property tax rate for Commercial Development Taxing Jurisdictions in Wards 7 and 8;
  • exclude Internet access from the sales and use taxes; and
  • allow the standard deduction for individual District filers who itemize federally.

The cumulative, FY 2000 - FY 2003, four-year revenue cost of this plan is $229 million (See Table on Page 9).

The Evans/Catania Plan, The Tax Parity Act of 1999, proposes to:

  • reduce real property tax classes and tax rates;
  • accelerate depreciation of computer equipment under the personal property tax;
  • establish a threshold for filing the personal property tax;
  • lower tax rates under the individual income, corporate and unincorporated business franchise taxes;
  • change the net operating loss deduction and eliminates carryback of losses; and,
  • exclude Internet access from the sales and use taxes.

The cumulative, FY 2000 — FY 2003, four-year revenue cost of this plan is $ 1.269 billion (See Table on Page 9).

The Orange Plan, The Real Property Tax Classes and Tax Rates Amendment Act of 1999, would reduce the rate of tax on assessed value of real property on all real property tax classes.

The cumulative, FY 2000 - FY 2003, four-year revenue cost of this plan is $335.8 million (See Table on Page 9).

Observations

It is clear that with or without tax reform, the District must have a balanced budget. Section (c)(1 )(A) of Public Law 104-8, the District of Columbia Financial Responsibility and Management Assistance Act of 1995, requires that the District keep its expenditures at or below its revenues. The current FY 2000 Budget before the City Council has a forward forecast of revenues over expenditures of approximately $127 million cumulatively over the four year period FY 2000 - FY 2003. This is the amount currently available for tax reduction without cuts to spending, offsetting tax increases elsewhere, or new revenue sources. To stay within the statutory spending constraints, tax reductions need be kept in this range or an alternative funding mechanism found.

Revenue Impact

The revenue impact of each bill by provision and Fiscal Year is shown in the table attached to this testimony. There are technical changes that need to be made to implement the stated intent. We are assuming that these technical changes will be made before the Committee approves any legislation. What is apparent is that the District can currently afford to enact only some of the proposed tax relief within our current revenue projections and spending plans. To pass legislation allowing tax relief that exceeds the District's current long-range financial plan could put the District's financial stability at risk.

Future Financial Stability

I would like to discuss the effect each proposal would have on the District's long term financial stability. Our analysis of all of the proposals under consideration assumes continuation of current Federal law requiring the District to establish and maintain a $150 million annual reserve. Although savings from long-term debt restructuring cover part of the cost of the Mayor's Plan the remainder of that Plan is predicated on a change in the reserve requirement.

Funding for the three remaining bills, the Schwartz Plan, the Evans/Catania Plan and the Orange Plan, is also predicated on a change in Federal law permitting use of the accumulated surplus for tax relief purposes. Each of these bills would require the use of the City's current accumulated surplus as the basis for funding continuing tax reductions. However, even with a law change, this surplus is effectively a fixed asset. Once the surplus is exhausted, which could occur within two or three years depending on the extent of the tax reduction, the City would be forced to drastically cut expenditures, rescind all or portions of the tax cuts, borrow additional funds, or run an annual budget deficit.

Impact Using Current Budget Constraints

Using current budget assumptions, and assuming all fund balances are applied to tax reduction including the accumulated surplus, the tax plans under consideration would have the effects on the District's fund balance shown in the chart on page 10 of this testimony.

The Evans/Catania Plan and the Schwartz Plan would both result in a negative fund balance beginning in FY 2001 and FY 2002, respectively.

The Evans/Catania Plan would produce negative balances ranging from $43 million in FY 2001 to $831 million in FY 2003.

The Schwartz Plan would produce a negative fund balance between $66 million in FY 2002 and $195 million in FY 2003.

The Mayor's Plan and the Orange Property Tax Plan would not result in negative fund balance before FY 2003.

Impact Assuming Economic Growth Continues

Assuming the District's economy continues the amazing performance seen over the last year, an assumption that is not part of the District's long-range financial assumptions or those of the Federal government either, the Evans/Catania Plan would result in a small negative fund balance ($31 million) in the year 2003. (See the chart on page 11 which assumes $200 million in additional revenue over the current forecast.) The other plans would retain positive fund balances through FY 2003.

Impact Assuming Economic Growth Ends

All the plans would produce negative fund balances if a recession were to occur. The negative balances would be as follows:

  • The Evans/Catania Plan -- $313 million in FY 2001 to $1.476 billion in FY 2003.
  • The Schwartz Plan -- $210 million in FY 2001 to $840 million in FY 2003.
  • The Mayor's Plan -- $10 million in FY 2001 to $434 million in FY 2003.
  • The Orange Plan -- $21 million in FY 2001 to $542 million in FY 2003.

Tax Policy Implications

As I stated at the beginning of my remarks, we must continue to address the vitally important questions of tax structure and tax relief in the District. In the long term, successful tax reduction must be coupled with broadening the inadequate tax base. Proposals need a firm base predicated on a continuing revenue flow. Our surplus is partly a result of the longest national economic expansion of this century — the continuation of this expansion should not be the foundation on which to premise major tax cuts. The District needs a reconfigured tax system that more equitably captures economic growth to support the more sweeping cuts suggested today.

Thank you very much. I would be pleased at this time to answer any questions you have.

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Comparison of Tax Reduction Proposals

($ in millions)

Assume Fully Phased-in FY2000 FY2001 FY2002 FY2003 Total
Business Tax Restructuring and Incentive Amendment Act of 1999 (The Mayor's Plan) 38.5 62.7 63.5 64.3 229.0
Choice of deduction method 2.2 3.0 3.0 3.0  
Eliminate Professional License Fee 7.2 7.2 7.2 7.2  
Increase Filing Threshold:          
$2 Mil. Req. Corp & UB, $2 mil. Arena &50K PPT 25.6 40.00 40.3 40.6  
Accelerate Dep. for Elect. Equipment 0.0 9.0 9.5 10.0  
NOL DC Specific/eliminate carry-back 0.0 0.0 0.0 0.0  
Reduct class 3, 4, 5 rates in Dev. Zones to $1.54 3.5 3.5 3.5 3.5  
Eliminate sales tax on Internet access 0.0 0.0 0.0 0.0  
           
Tax Parity Act of 1999 (The Evans/Catania Plan) 123.8 279.7 418.8 446.7 1,269.0
Filing Req. $2 mil. Arena, $50 K Pers. Prop. 0.0 6.0 6.3 6.6  
Accelerate Dep. for Elect. Equipment 0.0 9.0 9.5 10.0  
NOL DC Specific/eliminate carry-back 0.0 0.0 0.0 0.0  
Cut Corp/UB rates by 1% per year (9.975 to 6.5) 25.5 51.3 74.5 80.2  
Real Property Tax Rate Reductions:          
Class 2 reduction from $1.54 to $0.96 13.1 25.6 38.1 38.1  
Class 4 reduction from $2.15 to $1.85 16.8 33.5 50.3 50.3  
Class 5 reduction from $5.00 to $1.85 4.1 4.3 4.4 4.4  
Eliminate sales tax on Internet access 0.0 0.0 0.0 0.0  
Individual Income Tax Rate Reductions:          
$1-10K from 6% to 3% 15.8 36.9 58.0 63.3  
$10-20K 8% to 5% 10.8 25.2 39.6 43.2  
$20K+ 9.5% to 6.5% 37.7 87.9 138.1 150.6  
           
Tax Reduction Amendment Act of 1999 (The Schwartz Plan) 136.2 164.7 166.2 167.2 634.3
Eliminate Professional License Fee 7.2 7.2 7.2 7.2  
Reduce general sales rate from 5.75 to 5.0 36.0 37.5 39.0 40.0  
Eliminate sales tax on clothes less than $100 12.0 12.0 12.0 12.0  
Cut top income tax rate from 9.5% to 7.5% 81.0 108.0 108.0 108.0  
           
Real Property Tax Classes and Tax Rates Amendment Act of 1999 (The Orange Plan) 39.0 73.4 111.7 111.7 335.8
Real Property tax rate reductions:          
Class 1 from $.96 to $.86 5.1 10.2 12.8 12.8  
Class 2 from $1.54 to $0.86 13.0 25.4 44.2 44.2  
Class 4 from $2.15 to $1.85 16.8 33.5 50.3 50.3  
Class 5 from $5.00 to $1.85 4.1 4.3 4.4 4.4  

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Alternate Tax Proposals: Impact on Accumulated Fund Balance
Based on FY00 Budget Plan

  Fund Balance FY99 FY00 FY01 FY02 FY03
  Beginning $112 $312 $313 $361 $401
  Net Change $200 $1 $43 $40 $38
Budget Book, page 3 Ending $312 $313 $361 $401 $439
             
Reductions, Tax Parity Act (Evans/Catania) Fund Balance FY99 FY00 FY01 FY02 FY03
  Beginning $112 $312 $189 $(43) $(422)
  Net Change $200 $1 $48 $40 $38
  Proposed Tax Cut $- $(124) $(280) $(419) $(447)
  Ending $312 $189 $(43) $(422) $(631)
             
Reductions, Tax Reducations Amendment Act (Schwartz) Fund Balance FY99 FY00 FY01 FY02 FY03
  Beginning $112 $312 $177 $60 $(66)
  Net Change $200 $1 $48 $40 $38
  Proposed Tax Cut $- $(136) $(165) $(166) $(167)
  Ending $312 $177 $60 $(66) $(195)
             
Reductions, Real Property Tax Classes & Rates Amendment Act (Orange) Fund Balance FY99 FY00 FY01 FY02 FY03
  Beginning $112 $312 $274 $249 $177
  Net change $200 $1 $48 $40 $38
  Proposed Tax Cut $- $(39) $(73) $(112) $(112)
  Ending $312 $274 $249 $177 $103
             
Reductions, Business Tax Restructuring & Incentive Amendment Act (Mayor) Fund Balance FY99 FY00 FY01 FY02 FY03
  Beginning $112 $312 $274 $259 $235
  Net Change $200 $1 $48 $40 $38
  Proposed Tax Cut $- $(39) $(63) $(64) $(64)
  Ending $312 $274 $259 $235 $209

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Alternative Tax Proposals: Impact on Accumulated Fund Balance
Based on FY00 Budget Plan + $200M Annually

  Fund Balance FY99 FY00 FY01 FY02 FY03
Budget Book, page 3 Beginning $112 $312 $513 $761 $1,001
  +$200M   $200 $200 $200 $200
Budget Book, page 3 Net Change $200 $1 $48 $40 $38
  Ending $312 $513 $761 $1,001 $1,239
             
Reductions, Tax Parity Act (Evans/Catania) Fund Balance FY99 FY00 FY01 FY02 FY03
  Beginning $112 $312 $389 $357 $178
  Net Change $200 $201 $248 $240 $238
  Proposed Tax Cut $- $(124) $(280) $(419) $(447)
  Ending $312 $389 $357 $178 $(31)
             
Reductions, Tax Reducations Amendment Act (Schwartz) Fund Balance FY99 FY00 FY01 FY02 FY03
  Beginning $112 $312 $377 $460 $534
  Net Change $200 $201 $248 $240 $238
  Proposed Tax Cut $- $(136) $(165) $(166) $(167)
  Ending $312 $377 $460 $534 $605
             
Reductions, Real Property Tax Classes & Rates Amendment Act (Orange) Fund Balance FY99 FY00 FY01 FY02 FY03
  Beginning $112 $312 $474 $649 $777
  Net change $200 $201 $248 $240 $238
  Proposed Tax Cut $- $(39) $(73) $(112) $(112)
  Ending $312 $474 $649 $777 $903
             
Reductions, Business Tax Restructuring & Incentive Amendment Act (Mayor) Fund Balance FY99 FY00 FY01 FY02 FY03
  Beginning $112 $312 $474 $659 $835
  Net Change $200 $201 $248 $240 $238
  Proposed Tax Cut $- $(39) $(63) $(64) $(64)
  Ending $312 $474 $659 $835 $1,009

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Alternative Tax Proposals: Impact on Accumulated Fund Balance
Based on FY00 Budget Plan +Recession

  Fund Balance FY99 FY00 FY01 FY02 FY03
Budget Book, page 3 Beginning $112 $312 $193 $91 $(44)
  Recession Impact   $(120) $(150) $(175) $(200)
Budget Book, page 3 Net Change $200 $1 $48 $40 $38
  Ending $312 $193 $91 $(44) $(206)
             
Reductions, Tax Parity Act (Evans/Catania) Fund Balance FY99 FY00 FY01 FY02 FY03
  Beginning $112 $312 $69 $(313) $(867)
  Net Change $- $1 $48 $40 $38
  Proposed Tax Cut $- $(124) $(280) $(419) $(447)
After proposed tax cuts Ending $312 $69 $(313) $(867) $(1,476)
             
Reductions, Tax Reducations Amendment Act (Schwartz) Fund Balance FY99 FY00 FY01 FY02 FY03
  Beginning $112 $312 $57 $(210) $(511)
  Net Change $- $1 $48 $40 $38
  Recession Impact $- $(120) $(150) $(175) $(200)
  Proposed Tax Cut $- $(136) $(165) $(166) $(167)
  Ending $312 $57 $(210) $(511) $(840)
             
Reductions, Real Property Tax Classes & Rates Amendment Act (Orange) Fund Balance FY99 FY00 FY01 FY02 FY03
  Beginning $112 $312 $57 $(210) $(511)
  Net change $- $1 $48 $40 $38
  Recession Impact $- $(120) $(150) $(175) $(200)
  Proposed Tax Cut $- $(39) $(73) $(112) $(112)
  Ending $312 $154 $(21) $(268) $(542)
             
Reductions, Business Tax Restructuring & Incentive Amendment Act (Mayor) Fund Balance FY99 FY00 FY01 FY02 FY03
  Beginning $112 $312 $154 $(11) $(210)
  Net Change $- $1 $48 $40 $38
  Recession Impact $- $(120) $(150) $(175) $(200)
  Proposed Tax Cut $- $(39) $(63) $(64) $(64)
  Ending $312 $154 $(11) $(210) $(436)

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