Review of the Department of Employment Services' Surplus Tax Surcharge Funds
January 29, 1998

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EXECUTIVE SUMMARY

PURPOSE

Pursuant to a request from Councilmember Kathy Patterson, the District of Columbia Auditor reviewed the .1% tax surcharge for the District's Unemployment Trust Fund (Trust Fund). The surcharge resulted in a surplus of $5.4 million plus interest income of approximately $1,321,670, as of September 30, 1997. The Unemployment Trust Fund is managed by the Department of Employment Services (DOES).

CONCLUSION

The Auditor's examination of the .1% Unemployment Trust Fund surcharge and the resulting $5.4 million surplus did not disclose any violations of the laws and regulations of the District of Columbia regarding management of the surplus funds. The Auditor found that the accumulation of the $5.4 million in surplus tax surcharge funds was related to two factors: (1) the early repayment of loans; and (2) a revenue and expense projection that allowed for a surplus in revenue. The Auditor also found that the $1,321,670 in interest income earned on the surplus funds was not being posted to the Interest Account. The Auditor's review of the proposed spending plan for the surplus funds indicated that it lacked performance time- frames and a process for reviewing the implementation of planned improvements by an independent qualified reviewer.

The Department of Employment Services' spending plan and FY 1998 budget do not address the use of the $ 1,321,670 interest income. This situation should be monitored to ensure that a spending plan is developed for the interest income, and that any use of the interest income is approved through the appropriate process.

MAJOR FINDINGS

1. Spending plan lacked important elements.
2. Interest earned on tax surcharge funds was not reported by the Department of Employment Services.

RECOMMENDATIONS

1. That DOES annually request the Office of Finance and Treasury to compute interest income earned on idle funds in the Interest Account that are invested by the D.C. Treasurer;
2. That DOES report all future earned interest income in the appropriate FMS account; and
3. That the D.C. Treasurer post the computed earned interest income of $1,321,670 to the Interest Account.

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PURPOSE

Pursuant to a request from Councilmember Kathy Patterson, the District of Columbia Auditor reviewed the .1% tax surcharge for the District's Unemployment Trust Fund (Trust Fund). The surcharge resulted in a surplus of $5.4 million plus interest income of approximately $1,321,670, as of September 30, 1997. The Unemployment Trust Fund is managed by the Department of Employment Services (DOES).

OBJECTIVES, SCOPE AND METHODOLOGY

Our objectives were to:

1. determine the status of surplus tax surcharge funds in the Department of Employment Services' Interest Account after the payment of all outstanding loans and interest owed to the United States Treasury; and
2. evaluate a proposed spending plan presented by the Department of Employment Services to the Council of the District of Columbia for the expenditure of surplus tax surcharge funds to improve administration of the Unemployment Compensation Program.

We also answered seven (7) specific questions presented by Councilmember Patterson concerning the activities and events regarding the .1% tax surcharge funds. The seven specific questions were:

1. What were the dates that the surcharge was in place?How much money was collected from the surcharge, by year?
2. How much money from the Interest Account was used to pay interest on loans from the U.S. Treasury?
3. Why was the surcharge rate set at one-tenth of one per cent (.1 %)?
4. What is the cash balance in the Interest Account?
5. How have the funds been invested?
6. What was the amount of interest expense projected by the Department of Employment Services to meet borrowing requirements?
7. Was the projected amount reasonable?
8. At what point in time was it possible for management at the Department of Employment Services to know that the tax surcharge funds needed for interest payments would approximate only $1 million?

In order to achieve the objectives and answer Councilmember Patterson's questions, we examined related accounting and financial records at the Department of Employment Services for the period October 1, 1990 through September 30, 1997. We interviewed knowledgeable management personnel; reviewed D.C. Code, Sections 46-103(I) and 46-l l5(c); made inquiries at the U.S. Treasury concerning balances on loans and interest charges; and made inquiries at the D.C. Office of Finance and Treasury concerning interest income earned on idle tax surcharge funds. The Auditor reviewed the proposed spending plan to obtain an understanding of the proposed improvements and to determine if the plan included costs savings, performance time-frames for each task, and a process for reviewing the implementation and impact of improvements.

The audit was conducted in accordance with generally accepted government auditing standards and included such tests as were deemed necessary under the circumstances.

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BACKGROUND

The Department of Employment Services (DOES) is an agency of the District of Columbia government. Its mission is to serve as the primary vehicle for the development of a work force and work environment within the District of Columbia that supports a stable economic foundation for citizens, workers, businesses, and the general community. The agency's budget for fiscal year (FY) 1997 was $62,581,000 and 732 FTE's. The fiscal year 1998 budget is $57,591,000 and 664 FTE's, a reduction of $4,990,000 and 68 FTE's from fiscal year 1997.

The Department of Employment Services seeks to accomplish its mission through the development and implementation of employment programs and services for District workers and employers. Some of the programs offered by DOES include: employee training, job placement, assistance in maintaining employment, and employee benefits. The agency's largest program is the assessment and collection of a payroll tax from District employers for the payment of temporary benefits to eligible workers who are involuntarily separated from employment. DOES accounts for all taxes collected and disbursed for employee benefits through the Unemployment Trust Fund. DOES also administers the District's Workers Compensation/Disability Program and is responsible for ensuring the quality of the employer/employee work environment by proposing and enforcing laws that provide for the health, safety, rights and benefit of workers.

The agency's organizational structure includes the following major divisions:

• Executive Director/Administration;
• Budget, Accounting and Finance;
• Policy, Legislative and Statistical Analysis;
• Compliance and Independent Monitoring;
• Labor Standards; and
• Employment and Training.

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OVERVIEW OF ISSUES

The first issue concerns how DOES managed to collect money from the .1% tax surcharge that far exceeded the amount needed to pay interest charges on loans from the U.S. Treasury.

In January 1992, the Council of the District of Columbia approved legislation that authorized the Department of Employment Services to implement a .1% tax surcharge on employers (businesses) operating in the District. The purpose of the tax surcharge was to generate revenue to pay interest charges on loans made to the Unemployment Trust Fund. Financial projections prepared by DOES in 1991 revealed the need to borrow funds from the U.S. Treasury in order to meet revenue shortages in the Trust Fund. The tax surcharge generated approximately $6.4 million in revenue collections. However, the interest expense incurred and paid as a result of the loans amounted to only $1,055,016, leaving a surplus of approximately $5.4 million in tax surcharge funds. The $5.4 million in tax surcharge funds are accounted for in a special fund entitled "Interest Account" within the District's General Fund. D.C. Code, Section 46-115(c)(2) governs the Interest Account and requires that any surplus funds be transferred to the Unemployment Trust Fund.

The second issue concerns a June 1996 DOES request to the Council of the District of Columbia to enact legislation entitled, "Unemployment Compensation Enhancement Emergency Amendment Act of 1996." The legislation would authorize DOES to transfer the $5.4 million in surplus funds from the Interest Account to the Department of Employment Services' Special Administrative Expense Fund, and allow DOES to use the $5.4 million to make improvements in the administration of the Unemployment Compensation Program.

The legislation was approved by the Council, but disapproved by the District of Columbia Financial Responsibility and Management Assistance Authority (Authority). The Authority determined that the legislation was inconsistent with the financial plan and budget for fiscal years 1996 and 1997. Subsequent to this disapproval, at the request of the Authority, DOES submitted a spending plan which explained in detail how the surplus funds were to be used. The D.C. Board of Trade and the Council of the District of Columbia's Committee on Government Operations determined that the spending plan:

1. did not include performance benchmarks, time-frames for making proposed changes, and a process for review;
2. did not include estimated cost savings that should occur as a result of the improvements;
3. did not provide comparative data from other U.S. jurisdictions showing how similar improvement plans for unemployment funds have fared; and
4. had not been reviewed by representatives from the U S Department of Labor (DOL)

Approval of a revised spending plan is pending.

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HISTORY OF THE .1% TAX SURCHARGE

In 1991 it became apparent to DOES that the Unemployment Trust Fund would have to obtain a loan from the U.S. Treasury in 1992 to meet Trust Fund revenue shortages. If the District's Trust Fund reserves are inadequate to meet benefit outlays, a repayable advanced loan may be secured from the U.S. Treasury. Prior to 1981, such loans to the District and other states were interest free. However, the Omnibus Budget Reconciliation Act of 1981 imposed interest on any future loans made after March 31, 1982. The rate of interest charged is the existing treasury-bill rate at the time of the loan. Interest due to the federal government for Trust Fund loans can not be paid with regular unemployment insurance taxes collected from employers. Due to this restriction and the deficit financial position of the District government, DOES appealed to the Council of the District of Columbia to enact legislation that would require employers to pay the interest through a tax surcharge of .1%. The Council enacted D.C. Act 9- 146 (D.C. Law 9-200) entitled, "District of Columbia Unemployment Compensation Act Emergency Amendment Act of 1992," effective January 1, 1992, which established the .1 % tax surcharge as requested by DOES. The legislation also established a special fund known as the Interest Account in the District's General Fund. All revenues collected from the .1 % tax surcharge were deposited in the Interest Account. The surcharge was to be assessed to employers' regular unemployment insurance tax rate. The revenue from the tax surcharge would be used to pay interest expenses on loans from the U.S. Treasury. DOES assessed the tax surcharge for calendar years 1992 and 1993.

From July 1992 through May 1993, DOES borrowed $56.3 million from the U. S. Treasury. Related interest expenses incurred and paid to the U. S. Treasury amounted to $ 1,055,016. However, the District collected approximately $6.5 million from the tax surcharge. This left a surplus balance of approximately $5.4 million in the Interest Account. D.C. Code, Section 46- l l 5(c)(2) requires that all unexpended balances in the Interest Account be transferred to the Unemployment Trust Fund after certification by the DOES Director that the funds will not be needed to pay interest charges in the next calendar year. As of September 30, 1997, the director had not issued a certification. The certification is being withheld pending a decision by the Council of the District of Columbia and the Authority on the DOES request to use the surplus funds to improve the administration of the Unemployment Compensation Program.

District of Columbia Code, Section 46-103(I)(1) through (3) states:

(1) Commencing January 1, 1992, an interest surcharge of 0.1% shall be added to the contribution rate of each employer required to pay contributions by this chapter, excepting those reimbursing employers subject to the requirement of subsection (h) of this section.

(2) All interest surcharges collected under this subsection shall be considered separate from contributions required by subsection (c) of this section and shall be deposited in the Interest Account established by code section 46-l 15(c) and shall not be credited to the individual accounts of employers.

(3) No interest surcharge shall be required for any year following the year in which the amount of interest-bearing advances has been reduced to zero; provided, however, that an interest surcharge shall be reimposed by the Director of the Department of Employment Services ("Director") for the calendar following any year in which an interest-bearing advance remains outstanding on October 1 and where there are not sufficient funds in the Interest Account to pay the interest due for that year.

District of Columbia Code, Section 46-1 l5(c)(1) and (2) states:

(c)(1) There is created a special fund in the General Revenue Fund of the District of Columbia Treasury, which shall be separate from the District Unemployment Fund, to be known as the Interest Account. Notwithstanding any contrary provisions of this chapter:

(A) All interest surcharges collected from employers shall be deposited in the Interest Account; and

(B) All moneys in the Interest Account shall be used for the payment of interest assessed on interest-bearing advances received under Title XII of the Social Security Act.

(2) Any moneys deposited in the Interest Account that are unexpended after all interest-bearing advances and interest assessments are paid to a zero balance shall be transferred to the Unemployment Trust Fund upon certification by the Director that the unexpended funds will not be needed to pay interest charges in the next calendar year.

Accumulation of Surplus Tax Surcharge Funds Was Related to Two Factors

The current $5.4 million balance in the Interest Account represents the difference between total collections from the .1% tax surcharge and total disbursements for interest payments on loans. As of September 30, 1997, all outstanding interest obligations to the U.S. Treasury had been satisfied. The surplus surcharge funds are restricted in use to the payment of interest on advances made to the Trust Fund under Title XII of the Social Security Act. Any unexpended funds remaining in the Interest Account must be transferred to the Trust Fund. The Auditor found no violations by DOES in their management of the funds. However, questions were raised concerning how such a large sum of surplus funds were accumulated by DOES. The answer to this question is related to the following:

• Early Repayment of Loans

In fiscal year 1992, the Trust Fund borrowed $22.4 million from the U.S. Treasury. Approximately $15.8 million of this was repaid by June 1992. In fiscal year 1993, DOES borrowed $34.1 million. The entire $34.1 million along with the remaining $6.6 million borrowed in fiscal year 1992 was repaid in May 1993. Over a twenty-four (24) month period, these loans were outstanding for only eleven (11) months, or 46% of the time- period. This had a major impact upon the amount of interest that was incurred on the borrowed funds, and was determined by the Auditor to be one of the factors contributing to the accumulation of surplus funds in the Interest Account.

The early repayment of the loans resulted in an actual interest expense to the U.S. Treasury that was far less than the projected $4,760,000 in interest expense. The actual interest incurred and paid to the U.S. Treasury was only $1,055,016, which was $3,704,984 less than the projected $4,760,000. The early repayment of loans created a situation whereby the .1% tax surcharge was collected during periods when no loans were outstanding. The revenue collected during these periods represented a substantial portion of the surplus funds.

• Tax Surcharge Revenue Projections were Calculated to Allow for a Surplus

DOES's revenue and expense projections for 1992 and 1993 were calculated to allow a tax surplus of $ 1.24 million. The application of the .1 % tax surcharge rate to estimated employer wages of $6,000,000,000 for the two-year period would generate tax revenue of $6,000,000. This exceeded the projected interest expense of $4,760,000 (based on a 10% rate) by $1.24 million. The fact that the actual tax surcharge revenue of $6.5 million was $500,000 more than projected and the actual interest expense of $1,055,016 was much less than anticipated, produced an even larger surplus.

DOES management considered it reasonable to calculate tax surcharge revenue to allow for a surplus. Doubts concerning the collectibility of some accounts and uncertainty about the amount and duration of the Trust Fund's borrowing needs was the basis for their decision. This allowed management to err on the side of safety if projected revenues were not realized, or if actual expenses were greater than projected. If interest expenses had exceeded revenue collections, management would have been required to continue to collect the tax surcharge from employers into the next calendar year to cover the additional interest expenses.

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RESPONSE TO COUNCILMEMBER PATTERSON'S QUESTIONS

1. What were the dates that the surcharge was in place?

Response: The tax surcharge was in place for a two-year period from January 1, 1992 through December 31, 1993. However, tax surcharge revenue collections were on-going through FY 1996 due to delinquent accounts.

2. How much money was collected from the surcharge, by year?

Response: Table I presents surcharge revenue collected by DOES during fiscal years 1992 through 1996. Surcharge revenue collected in fiscal years 1994, 1995, and 1996 represented delinquent payments of the .1% surcharge assessed in calendar years 1992 and 1993.

Table I

3. How much money from the Interest Account was used to pay interest on loans to the Unemployment Trust Fund?

Response: Table II presents interest payments made on loans to the Unemployment Trust Fund during fiscal years 1992 and 1993. A total of $ 1,055,016 in interest payments were made on loans to the Unemployment Trust Fund.

Table II

4. Why was the surcharge rate set at one-tenth of one per cent?

Response: It appears that DOES set the surcharge rate at .1 % (one-tenth of 1%) in order to meet its projected interest expense of $4,760,000 on loans for calendar years 1992 and 1993. The .1% rate was projected to generate approximately $3 million per year in revenue based on annual employers' taxable wages of approximately $3,000,000,000. Table III presents DOES's calculation of the projected interest expense for calendar years 1992 and 1993.

Table III

5. What is the cash balance in the Interest Account? How have the funds been invested?

Response: According to officials in the Office of Finance and Treasury, all idle funds of the General Fund, including funds in the Interest Account, are invested short-term with preselected financial management companies. As of September 30, 1997, the District's Financial Management System (FMS) reported the Interest Account balance at $5,460,065. The D.C. Treasurer's computed interest income on the invested funds was approximately $1,321,670 as of September 30, 1997. Total accumulated funds as of September 30, 1997 was approximately $6,781,735.

The $1,321,670 in interest income has not been posted to the Interest Account in FMS. The Office of Finance and Treasury's policy is to compute interest on idle funds of government agencies only when requested by the agency. Each individual agency is responsible for posting the interest to their FMS account.

6. What was the amount of interest expense projected by DOES to meet borrowing requirements? Was the projected amount reasonable?

Response: Table IV presents the interest expense projected by DOES to meet borrowing requirements. The projection appeared to be reasonable based on a projected borrowing of $47.6 million over a two-year period at 10% simple interest. (Table III presents a calculation of the projected interest expense.)

Table IV

7. At what point in time was it possible for DOES to know that the tax surcharge needed for interest payments would approximate only $1 million?

Response: In the early months of 1993, due to an increase in the employer taxable wage base and the restructuring of tax rate schedules, the Trust Fund began to regain solvency. In May 1993, management repaid $40,671,190 to the U.S. Treasury for all outstanding loans to the Trust Fund. The decision by management to make an early repayment of loans can be viewed as an indication of confidence in the Trust Fund's ability to sustain solvency. Therefore, it appears that management was aware, at that point, that the .1% tax surcharge revenue would far exceed the interest expense incurred on loans. Consistent with the requirements of D.C. Code, Section 46-103 (I) (3), management correctly suspended the tax surcharge at the end of calendar year 1993 after all loans and interest payments were made to the U.S. Treasury.

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FINDINGS

SPENDING PLAN LACKED IMPORTANT ELEMENTS

The Auditor reviewed the DOES spending plan presented to the Council of the District of Columbia along with the proposed legislation that would allow DOES management to use approximately $5.4 million in surplus tax surcharge funds to make improvements in the administration of the Unemployment Compensation Program. The spending plan identified areas of the Unemployment Compensation Program in need of administrative improvements. The plan also included estimated costs of implementing the improvements. The Auditor's review was limited to gaining an understanding of the proposed improvements; how the changes would differ from the current functions; the expected savings in dollars and staff hours; and whether the plan included performance time-frames and a performance review process.

DOES provided the following summary of proposed expenditures in the spending plan:

Summary of Expenditures by Fiscal Year

Fiscal Year 1998

Fiscal Year 1999

Fiscal Year 2000

The Auditor found that the spending plan lacked important elements that would provide better understanding of the anticipated results from the proposed expenditures. The spending plan lacked:

1. information on potential cost savings and staff reductions as a result of automating;
2. information on the effectiveness of similar administrative and automation improvements made by unemployment compensation program administrators in other U.S. jurisdictions;
3. the inclusion of date specific time-frames for implementing the improvements;
4. a monitoring system that included the preparation and issuance of periodic progress reports by an independent qualified reviewer;
5. methods to measure outcome; and
6. review of the planned improvements by the United States Department of Labor for compliance with U.S. regulations and standards.

RECOMMENDATION

That DOES incorporate the above elements into its spending plan to provide a better framework for the Council of the District of Columbia, the Authority, and other interested parties to review the merits of the spending plan.

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INTEREST EARNED ON TAX SURCHARGE FUNDS WAS NOT REPORTED BY DOES

The annual interest income earned on the idle tax surcharge funds in the Interest Account is not being reported by DOES. As a result, the account balance reported in FMS is understated. The FMS reported balance at September 30, 1997, which did not include interest earned, was $5,460,065. The Office of Finance and Treasury, which invests all idle funds of the General Fund, reported that approximately $1,321,670 in interest income had been earned on idle tax surcharge funds since 1992. With the addition of this income, the proper FMS reported balance should be approximately $6,781,735 at September 30, 1997.

The Office of Finance and Treasury has a policy of not computing interest earned on an agency's idle funds unless requested by the agency. The Department of Employment Services has not requested the D.C. Treasurer to compute interest earned on the idle tax surcharge funds. The Auditor believes that the Office of Finance and Treasury should compute and report interest income earned on all the invested funds of an agency on a periodic basis; and that each agency should record the earnings in FMS. This will avoid the understatement of an agency's fund balance in FMS and any resulting misinformation.

RECOMMENDATIONS

That DOES annually request the Office of Finance and Treasury to compute interest income earned on idle funds in the Interest Account that are invested by the D.C. Treasurer; That DOES report all future earned interest income in the appropriate FMS account; and That the D.C. Treasurer post the computed earned interest income of $1,321,670 to the Interest Account.

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CONCLUSION

The Auditor's examination of the .1% Unemployment Trust Fund surcharge and the resulting $5.4 million surplus did not disclose any violations of the laws and regulations of the District of Columbia regarding management of the surplus funds. The Auditor found that the accumulation of the $5.4 million in surplus tax surcharge funds was related to two factors: (1) the early repayment of loans; and (2) a revenue and expense projection that allowed for a surplus in revenue. The Auditor also found that the $1,321,670 in interest income earned on the surplus funds was not being posted to the Interest Account. The Auditor's review of the proposed spending plan for the surplus funds indicated that it lacked performance time-frames and a process for reviewing the implementation of planned improvements by an independent qualified reviewer.

The Department of Employment Services' spending plan and FY 1998 budget do not address the use of the $1,321,670 interest income. This situation should be monitored to ensure that a spending plan is developed for the interest income, and that any use of the interest income is approved through the appropriate process.

Respectfully submitted,
Deborah K. Nichols
Interim District of Columbia Auditor

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AGENCY COMMENTS

On December 1, 1997, the Of fice of the District of Columbia Auditor transmitted this report, in draft, to the Department of Employment Services and the Office of Financial Operations and Systems. On January 8, 1998, the Auditor submitted the excerpt from the draft report concerning interest income on invested tax surcharge funds to the Office of Finance and Treasury for review and comment.

Comments on our draft report were received from the Department of Employment Services on December 16, 1997. The Office of Financial Operations and Systems and the Of fice of Finance and Treasury did not comment on the draft report. Where appropriate, changes to the final report were made to reflect the comments. The comments in their entirety are appended to this report.

Government of the District of Columbia – Department of Employment Services
Office of the Director – Employment Security Building – 500 C Street, N.W. – Suite 600 – Washington, D.C. 20001

December 16, 1997

Ms. Deborah K. Nichols
Interim District of Columbia Auditor
Office of the District of Columbia Auditor
The Presidential Building
415 12th Street, N.W., Room 210
Washington, D.C. 20004

Dear Ms. Nichols:

The Department of Employment Services (DOES) has reviewed your draft report entitled "Department of Employment Services' Surplus Tax Surcharge Funds." Our comments are as follows.

We are pleased that your report substantiated that the Department committed no violations in the management of the surcharge funds. It was never this Department's intent to build up a sizeable surplus of surcharge funds. Our intent was to assure that there would be sufficient revenue to repay all interest charges that accrued to our Trust Fund loans.

We do not concur in your findings that our proposed spending plan for the surplus surcharge funds lacks crucial elements of a spending proposal. However, we agree that additional details could be included about the cost saving and productivity improvements that other states have experienced in implementing the various initiatives that comprise our spending plan. Additionally, we agree that a review of our plan by the U.S. Department of Labor would be beneficial. We also concur in your finding and recommendation regarding the computing and reporting of interest earned on funds in the Interest Account.

We suggest that clarifying language be added to the answer to question No. 7 posed by Councilmember Patterson (page 1 1). The report needs to make clear that the end of calendar year 1993 was the appropriate time for DOES to suspend collection of the tax surcharge. Section 46103(1)(3) specifies that "no interest surcharge shall be required for any year following the year in which the amount of interest-bearing advances has been reduced to zero." The amount of interest-bearing advances was reduced to zero in May of 1993. Accordingly, no interest surcharge was assessed against employers for the following 1994 calendar year.

We further suggest that clarifying language be added to the second paragraph of the section entitled "Tax Surcharge Revenue projections were Calculated to Allow for a Surplus" (pages 14 and 15). If interest expenses had in fact exceeded revenue collections, DOES would have had to pay the interest due from other resources; it could not have delayed payment of interest until additional tax surcharge revenues had been collected. Additionally DOES could not in fact have continued to collect the surcharge beyond calendar year 1993 because all interest bearing loans had been reduced to zero in that year.

If there are any questions with regard to this response, your staff may contact Mr. James Oxenburg, Chief of the Tax Division, on (202) 724-7462.

Sincerely yours,
Carolyn Jones
Interim Director