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Government and People
TO: The Honorable Anthony A. Williams, Mayor
FROM: Natwar M. Gandhi, Chief Financial Officer
DATE: June 27, 2002
RE: Advisory on Reduced Local Source Revenue, Medicaid Receivables, and Spending Pressures for FY 2002
As I have briefed you over the last few days, based on a rapidly changing financial revenue picture, some very strict expenditure measures are needed, due to a rapidly changing revenue picture, to ensure a balanced FY 2002 budget.
The need arises from a combination of: 1) a newly estimated $75 million revenue shortfall in revenues, which is similar to what has been occurring throughout the country; 2) persistent receivable shortfalls in Medicaid receivables; and 3) residual spending pressures still to be resolved.
The Office of the Chief Financial Officer (OCFO) estimates that over 80 percent of the $75 million revenue shortfall will have to be met with savings from District-wide adherence to a very strict expenditure budget for the remainder of this fiscal year.
This memorandum discusses each of the factors of immediate concern, those measures the OCFO has already taken and what the OCFO proposes to ensure a balanced budget. These measures would include freezes on hiring, overtime, and spending from non-personal services, as well as and converting eligible "O"-type revenues into unrestricted local funds.
New Estimate of Local Source Revenue Shortfall
FY 2002 local source revenues are currently expected to be $3,415.7 million,1 or $75 million lower than the estimate certified on May 6, 2002.
A sudden and steep drop in individual and business income tax collections occurred in the months of April and May, as reported in the May 15th and June 17th cash reports (see Attachment 1). The reasons are: 1) a very sharp drop in payments that accompany individual income tax returns, 2) quarterly payments received for non-wage income that are notably short in April and May, and 3) a significant increase in tax refunds paid out. Three measures for gauging individual income tax collections are resident employment, personal income, and the behavior of the financial markets. Resident employment — the source of D.C. withholding payments — continues to be about 1.7% percent below last year, when we had counted on expected only a 1.0% percent reduction. Personal income in D.C. is now thought to be growing at a rate of 2.0% percent, rather than the 2.8% percent earlier anticipated. The financial markets continue to decline and are now below expected levels, even after assuming that financial assets were over-valued two years ago.
The May revenue estimate assumed a very strong economic recovery for the second half of calendar year 2002the year. But since the May estimate, most economists are adopting a more pessimistic economic outlook for the second half of calendar the year 2002, due to the recent downward slide in the stock markets, weaker than expected employment figures, and an unexpected drop in consumer confidence. A 13.2 percent decrease fall in overall individual income tax collections for D.C. through the month of May, combined with the more pessimistic economic outlook, has caused us to revise the May estimate for FY 2002 individual income tax revenue down by $130 million for the entire year.
Corporate franchise tax collections also are below the prior estimate for FY 2002. Refunds of this tax — which reduce net revenue — are $18 million ahead of FY 2001 year-to-date collections,2 jumping to 167 percent ahead of FY 2001 by the end of May (See Attachment 2). Furthermore, since May, the economic outlook has become decidedly more pessimistic as the stock market has begun continued a downward slide and growth in corporate profits has failed to recover as initially forecasted. As a result, we no longer believe the recovery in corporate franchise tax revenue previously forecasted for the latter part of the fiscal year will materialize. We have revised the May estimate for the FY 2002 corporate franchise tax revenue down by $21.7 million..
The neighboring states of Maryland and Virginia, as well as the United States as a whole, also experienced a drop in revenue. The 13.2 percent fall in overall individual income tax collections for D.C. through the month of May is greater than the 6.9 percent decline for Maryland and the 7.7 percent decline for Virginia, but less than the 20.3 percent decline for the U.S . (See Attachment 1).
The conditions causing this drop are not confined to the District or the region. Highlights of a report on state revenues3 include:
The District recently received some important one-time revenues that help to offset the estimated $130 million individual income tax loss and $21.7 million corporate income tax loss, in addition to and some losses in sales and use tax. On a net basis, revenue is now expected to be $75 million less than previously forecast.
Recouping this loss with economic improvements between today and September 30 is almost impossible. A stunning and sudden rebound in the stock market might close part of the gap in quarterly declaration payments, but not all. But aA stunning rebound is not expected. Nor do we expect sudden growth in resident employment or personal income. None of these variables is likely to change quickly enough to regain revenue losses. Indeed, our concerns need to be focused on whether we will lose additional economic ground and experience larger revenue losses. The $75 million net shortfall is based on slow improvement of the economy across the summer and, by implication, assumes that D.C. does not have experience a "double-dip" recession.
It is too early to quantify the effects of this new information for FY 2003. By August, after the next update by CBO the Congressional Budget Office at the end of July, we will make a new estimate. In the meantime, we will maintain a close watch on revenues and keep the Mayor and Council apprised of changes in the projections.
In addition to these revenue pressures, the District again faces new spending pressures in FY 2002. Most pressures are now for items beyond the District’s control, such as court settlements for past actions. Other pressures, like the Medicaid reimbursement problem, arise from the turn-around time needed to implement measures that repair long- standing problems. Remaining spending pressures for FY 2002 total $301.6 million. All of the current spending pressures can be met with the balance in the reserves.
Medicaid and Medicare Receivables Shortfall
Medicaid receivables are expected to experience a total shortfall of $12.0 million. While Medicaid and Medicare are a federal revenue sources, the shortfall in collections means that local revenue must be spent to fill the gap. Since Because Medicaid and Medicare are is an entitlements, the District is obligated to provide as no legal mechanism to stop spending for Medicaid- eligible persons with and services.
We continue to be challenged by poor billing infrastructure and processes. Although we have made tremendous strides during the past several months in tracking Medicaid revenues bi-weekly, improving the performance of Maximus and reengineering our billing processes, it appears that we will have shortfall of $12.0 million at the Department of Mental Health . This shortfall is precipitated by the fact that they began billing May 15, 2002, for FY 2002 services. The Department of Mental Health recently identified the $12.0 million revenue shortfall associated with Medicaid and Medicare services stemming from: 1) an error in the calculation of allowable days for Medicaid reimbursement; 2) a correction to the projected Disproportionate Share payment amount; and 3) recent changes to federal Medicare reimbursement rules that affect state-operated, all-inclusive-rate psychiatric hospitals (i.e., St. Elizabeth Hospital).
We have made significant progress over the past several months in developing a process for revenue projecting and performance monitoring. However, it is imperative that we accelerate our efforts to establish timely, cost-effective revenue generation It is imperative that we devote the resources and provide the focus to ensure that proper documentation of services and appropriate billing practices are executed to minimize revenue shortfalls prospectively.
Based on our meeting with John Koskinen, the Director of the Child and Family Services Agency (CSFA) Child and Family Services Agency (CFSA) and the Chief of Operations Chief of Operations at schools, we anticipate no emerging spending pressures at those agencies.
It is the OCFO recommendation of the OCFO that the Medicaid Reform Office be established immediately to begin transformational reengineering of the billing/documentation processes.
Other Current Spending Pressures
The remaining $1826.6 million in current spending pressures stem from external judgments and settlements: $11.1 million stemming from past reductions-in-force (RIF)s – ($10 million from 1999 RIFs at the University of the District of Columbia and $1.1 million from recent RIFs at the Department of Corrections – and $7.5 million from court judgments.
Proposed Gap Closing Measures
The OCFO estimates that over 80 percent of the $75 million revenue shortfall will have to be met with savings from District-wide adherence to a very strict expenditure budget for the remainder of this fiscal year. We are considering any possible short-term initiatives to raise revenue. However, because we are now nine 9 months into the fiscal year, few revenue strategies are available, and our focus must be on expenditures. These would include freezes on hiring, overtime, and spending from non-personal services, as well as and converting eligible "O" type revenues accounts into unrestricted local funds.
These will be difficult budget measures for the final three months of the fiscal year. If agencies voluntarily forego expenditures that are either optional or can be delayed, the hardship may be reduced, and these measures should be strongly encouraged. With decisive action, we expect that the problem can be handled without adding personal hardships for employees such as furlough days or reductions-in-force.
The financial viability of the District is paramount. Early next week the OCFO will present the budget options that would ensure that viability through FY 2002. The concern obviously extends to FY 2003 and later years. In August, the OCFO will present the Mayor and Council budget options to continue the District’s financial viability into FY 2003.
I will keep you updated as the fiscal year progresses. In the meantime I look forward to your support in bringing expenditures in line with current forecasts of revenue generation in FY 2002.
Cc: John Koskinen, City Administrator
1. This includes tax revenue, non-tax local source revenue, and lottery revenue. It does not include federal payments for support of federal programs; grant, private and other revenue; or any transfers from accumulated fund balances.
2. After adjusting for a court settlement booked to FY 2001.
3. State Revenue Report #48, June 2002, Fiscal Studies Program, The Nelson A. Rockefeller Institute of Government, State University of New York.
4. State Fiscal Update, June 2002, June 4, 2002, National Conference of State Legislatures, Federation of Tax Administrators, national Association of State Budget Officers, Nelson A. Rockefeller Institute of Government.
5. Collections adjusted for cash representing revenue booked to FY 2001.
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