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Earmarking Tax Revenues in the District of Columbia: A Description and Evaluation
Mark I. Gripentrog
January 1998

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EARMARKING TAX REVENUES IN THE DISTRICT OF COLUMBIA

   A DESCRIPTION AND EVALUATION

A Draft Report Prepared for the District of Columbia Tax Revision Commission

By Mark I. Gripentrog, Financial Economist, District of Columbia Office of Tax and Revenue, Tax and Economic Policy Administration

November 28, 1997  


TABLE OF CONTENTS

Executive Summary
Overview
The National Picture
Advantages of Earmarking
Disadvantages of Earmarking
Discussion of Specific District of Columbia Earmarked Budget Items
General Obligation Bonds
Washington Metropolitan Area Transit Authority
Convention Center Fund
New Sports Arena
Convention Center Promotion Activities
Federal Highway Trust Fund
Policy Issues Concerning Earmarking in the District of Columbia
Conclusion
TABLES
Table 1 Historical Data on Earmarking Among States
Table 2 Number of States Earmarking Specific Taxes
Table 3 Summary of District of Columbia Earmarked Revenues by Source
Table 4 District of Columbia Earmarked Revenues by Purpose
Table 5 Rate Structure for Arena Fee
Table 6 District of Columbia Earmarked Revenues by Revenue Source
FIGURE
Figure 1 FY 1996 District Tax Revenues

EXECUTIVE SUMMARY

The dedication (earmarking) of all or part of tax revenues for specific expenditures and/or programs is a common practice among jurisdictions in the United States. The District of Columbia experience is similar to that of the average state in the United States. The percentage of District taxes earmarked (23% in FY 1996) is close to the 24% average for all states in 1993.

There are six major expenditure categories for which tax revenues are earmarked in the District. The six categories and a brief description of revenues earmarked to fund them follow: 

General Obligation Bonds

Earmarking of real property tax revenues to make general obligation bond payments is mandated by District law and by bond covenants between the District of Columbia and general obligation bond holders. Semiannual general obligation bond payments for principal and interest are provided by a calculated portion of the real property tax. The percentage of real property taxes earmarked for this purpose will be 75 percent in FY 1998. This earmarked portion of the real property tax was 46 percent as recently as FY 1993. If current trends continue an additional revenue source will need to be identified for this expenditure purpose within the next five years. Any change in the earmarking for general obligation bond payments will require a revision in the District's bond covenants.

Washington Metropolitan Area Transit Authority

The District of Columbia is part of the Washington Metropolitan Area Transit Authority (WMATA), a regional body charged with operating the mass transit system in the Washington area. Several different tax sources are allocated to WMATA. Earmarked revenues for WMATA are almost $150 million above actual expenditure needs for this fund. Despite the legal authority to use unneeded funds for general fund purposes, the allocation of these tax sources may prevent other desired earmarking.

Convention Center Fund

Portions of the sales tax, hotel occupancy tax and corporate and unincorporated business franchise tax are earmarked for construction of a new Convention Center. There is a provision in District law which allows the Executive to increase rates for these earmarked taxes in any year it is deemed there will not be enough to pay for the expected expenditure and reserve requirements. The restaurant sales tax component of the earmarked taxes is exempt from this provision. The potential administrative difficulty if this provision is required is difficult to overstate.

New Sports Arena

The Arena Fee is a new tax imposed to finance site acquisition and development costs of the recently completed MCI Center. The Arena Fee is a tiered flat-rate tax based on District gross receipts. The required revenue is $9 million per year. Arena Fee rates are required to be increased in any year in which $9 million in collections will not be reached. Such rate increases are to be made administratively and do not require Council approval. The Arena Fee bond covenant limits the use of Arena Fee revenues to payment of bonds for site acquisition and development costs.

Convention Center Promotion Activities

Sixty percent of the hotel occupancy tax is earmarked for the promotion of Washington Convention Center Authority activities in the District of Columbia. Three different promotional organizations receive these funds. There is less specificity in the expenditure of these funds than for other expenditures supported by earmarked revenue sources.

Federal Highway Trust Fund

Federal law requires that the District of Columbia motor vehicle fuel tax be deposited into a dedicated highway fund. This fund is used to pay for federal cost-sharing requirements and for special increased federal highway fund shares that were provided for the District in the recent past. This earmarking has resulted in an increased audit presence by the General Accounting Office and substantial staff time to provide the appropriate records for such audits.

Policy Issues

The major policy issue concerns the extent of future earmarking in the District of Columbia. Earmarking can increase, decrease or stay the same as current levels. The decision about future earmarking will be affected by the source of the earmarking recommendation (Congress, bond holders, the public). The trend in expenditure levels relative to earmarked revenue source levels will also affect the level of future earmarking.

A second policy issue is the communication of earmarking policies to the public and policy makers. There is currently no budget requirement to separate earmarked revenue sources from those available to finance the general budget. No annual reporting is available on the extent of earmarking within the District of Columbia.

Finally, there are few explicit annual or lifetime dollar limits on earmarked tax revenues. Ideally, an earmarked revenue source should grow at levels comparable to the expenditure for which the revenue source is dedicated. There should be some annual or lifetime limit on the amount of tax revenue earmarked for each program or expenditure.

Related Policy Issue

1. While this report focuses on earmarking of tax revenues, there is movement among District of Columbia agencies to earmark fees and fines for agency purposes. Such earmarking will, of course, reduce general fund revenues. Agencies earmark revenues to provide a reliable source of funds for automation and modernization expenditures. The District Council has introduced legislation earmarking a portion of fee and fine revenue for agency use.


OVERVIEW

Earmarked revenues (or dedicated revenues) are an important part of the state and local government financial system. Every state earmarks at least some portion of its tax revenues for specific programs or expenditure categories. Purposes for which taxes are earmarked range from funding a snowmobile account (Minnesota) to state and/or local highway construction and maintenance (all states). The percentage of earmarked tax revenues from state to state varies from 4 percent in Kentucky to as high as 87 percent in Alabama.(1) The District of Columbia falls somewhere in between these extremes with 23 percent of its tax revenues earmarked for specific purposes. This is close to the national average for states, which was 24 percent in FY 1993.(2)

By definition earmarking is a designation of all or part of a revenue stream to specific programs or expenditure categories. The normal state government practice is to appropriate funds from a general fund pool, which is based on total revenues for a jurisdiction. In the earmarking process a specific part of a revenue source is set aside to fund a designated project or expenditure category. For example, a state may direct that a percentage of its sales tax on lodging be used only to promote tourism. This revenue is not available to fund any other programs or expenditure categories. The tourism promotion expenditure category in this example is subject to fluctuations of the earmarked revenue source from one year to another unless augmented by revenue infusions from other general fund revenue sources.

Several earmarking practices are currently used. For example, a revenue source may be earmarked with a specific dollar maximum for an expenditure purpose. All revenues from the earmarked source above the specified dollar amount would be available for general fund expenditure. Another approach is to limit an earmarked revenue source to a specific time period. These approaches and others tend to mitigate "the drain" on general fund budgeting.

This report describes the earmarking practices for District of Columbia taxes and budgetary and revenue implications thereof. State earmarking practices are used as a reference point. A summary of earmarked District of Columbia tax revenues is provided and options are discussed concerning the District's earmarking practices.

The National Picture

Earmarking is widely practiced by federal, state and local governments. State governments earmark a wide variety of taxes and revenue sources. Each of the fifty states dedicates some portion of its revenue stream for specific budgetary purposes. The leader is Alabama with 87 percent of its taxes earmarked for specific purposes. The lowest percentage of earmarked taxes is found in Kentucky at 4 percent. In the average state 24 percent of state taxes were earmarked in 1993, an increase from 21 percent in 1984 and the same as 1988. The 1993 earmarking percentage represents a revival of interest in earmarking after a long fall from 51 percent of revenues in 1954 to 21 percent in 1984. This percentage would have been higher in 1993, except that collections from severance and motor fuel taxes, which are earmarked at a rate above the state average, did not keep pace with overall tax collections in several states.(3) Table 1 depicts the percentage of state revenues earmarked over the years surveyed by the National Conference of State Legislatures (NCSL). 

Table 1 HISTORICAL DATA ON EARMARKING AMONG STATES
Year  Average State 
Earmarking Percent
Highest State 
Earmarking Percent 
Lowest State 
Earmarking Percent
       
1954  51%  89%  0%
1963  41%  87%  2%
1979  23%  88%  0%
1984  21%  89%  1%
1988  24%  89%  5%
1993  24%  87%  4%

Source: Arturo Perez and Ronald Snell, "Earmarking State Taxes, Third Edition" (Denver Colorado: National Conference of State Legislatures, 1995, page 22)

One of the earliest revenue sources earmarked for specific purposes in the United States was lottery revenue. Lottery funds were used for many purposes including funding the Revolutionary War, the founding of Harvard, Yale and Dartmouth, financing specific construction projects, and [waging] campaigns in the French and Indian Wars. (4) Such earmarking of revenue sources, particularly lotteries, was a fairly common practice in 19th century United States government finance.

The most frequently earmarked tax by states is the motor fuel tax, which provided 29 percent of all earmarked revenues for states in 1993. Table 2 below indicates the number of states which earmark all or a portion of each of eleven different revenue sources. All fifty states earmark motor fuel taxes with the primary use of the earmarked funds being for highways and other transportation purposes and for local government assistance usually associated with local transportation needs. Other frequently earmarked taxes include general sales taxes (33 states), motor vehicle registration (32 states), tobacco taxes (27 states), alcoholic beverage taxes and severance taxes (24 states each). What Table 2 does not show is that a specific revenue source can be earmarked for a variety of different purposes. For example portions of the general sales tax in Idaho are earmarked for cities, counties, water pollution, state buildings and property tax relief, although no more than 10 percent of the sales tax is earmarked for any of the specific purposes noted. (5)

The tax sources used for earmarking noted in Table 2 will grow at different rates. The personal income and sales taxes will tend to grow at or above the level of inflation. Motor fuel taxes, registration, tobacco, severance and alcoholic beverage taxes are all based on units of consumption and will normally grow more slowly than the level of inflation. Corporate income, property taxes and public utility taxes are likely to be more volatile. It is important to understand the nature of the selected revenue source when earmarking for a specific budget purpose. Earmarking a slow growing revenue source for a rapidly growing budget expenditure can result in a mismatch in future years. 

Table 2 NUMBER OF STATES EARMARKING SPECIFIC TAXES
Type of Tax Number of States 
Earmarking
   
 Personal Income 17
Corporate Income *  17
General Sales/Gross Receipts *  33
Motor Fuel *  50
Motor Vehicle Registration *  32
Tobacco Taxes  27
Severance Taxes  24
Alcoholic Beverage Taxes  24
Property Taxes *  14
Public Utility Taxes  12 
Pari-mutuel  10

* Taxes fully or partially earmarked by the District of Columbia

Source: Arturo Perez and Ronald Snell, "Earmarking State Taxes, Third Edition" (Denver Colorado: National Conference of State Legislatures, 1995, pp. 40,41)

Some of the more common purposes for earmarking other than transportation include education and local government aid. As noted in the NCSL report there is a geographical dimension to earmarking. Earmarking for educational purposes is prevalent in the southern and western states of the United States and not so popular in the Northeast. (6)

Many, but not all, earmarked taxes have a relationship to the purpose for which they are earmarked. Examples include earmarking a small portion of alcoholic beverage taxes for wine grape research (Washington) or earmarking a small portion of motor fuel taxes for snowmobile

research (Minnesota). Some taxes are imposed specifically to fund a program. For example Florida imposes a citrus tax, all of which is earmarked for citrus advertising. The District of Columbia Arena Fee funds the new sports arena.

A new tax or fee earmarked 100 percent for a specific program may be imposed in an attempt to ensure there is no shift in funds away from other programs due to the earmarked activity. That only works, however, in states with no spending limitations. States with spending limitations have a reduction in general purpose budget whether an earmarked revenue source is an existing tax or a new tax.

Because earmarking often impacts general purpose budgets and reduces flexibility to solve local problems, the decision to earmark has consequences. Some of the advantages and disadvantages of earmarking are discussed below.

Advantages of Earmarking

  1. Earmarking can link a particular government service to taxes paid by users of the service. The most prevalent example of this linkage is motor fuel taxes. Presumably, highway and street users pay for their use of roadways through motor vehicle taxes and related fees. The question remains, however, about who pays for the external effects of increased automobile use such as a higher level of air pollution.
  2. Earmarking can guarantee that particular programs are funded at some minimum threshold level. For example, earmarking funds for education may be an attempt to "insure" that some funds are available for this purpose no matter what happens to the local economy and tax collections. "Something is better than nothing". However, "something" may not be enough and additional revenues from other sources may be necessary.
  3. Earmarking can alleviate the harmful effects of a related service or substance. Examples include earmarking tobacco taxes for health programs and earmarking Lottery proceeds to fund programs to assist gambling addicts.
  4. Earmarking can support desirable purposes for which it is otherwise difficult to secure sufficient funding. Football stadiums and sports arenas may fall into this category. Such earmarking provides comfort for legislators who do not support financing the programs with general fund revenues.

Disadvantages of Earmarking:

  1. Expenditures financed by earmarked revenue sources are not subject to the same level of annual or biennial legislative oversight as other items budgeted by state government. As one author noted, "... inertia - and the obstacles in the way of statutory or constitutional alteration - leads to the continuance of artificial earmarking".(7) Once a program is funded with earmarked funds, the level of legislative expenditure review may become less rigorous than that for other programs.
  2. Earmarking skews the budget process. Expenditure levels for earmarked programs can reduce funds available for other worthy programs. Distortions introduced by earmarking may be difficult to correct. This is most clearly illustrated by the situation in Alabama where 87 percent of revenues were earmarked in 1993. According to Bradley Byrne of the Alabama Board of Education, "the General Fund is not big enough".(8) Mr. Byrne goes on to say that Alabama's largest earmarked fund (education) is a target for any cause that can be remotely linked to education, including $650,000 for a "child's museum" within the headquarters of the Cattlemen's Association.(9)
  3. Separate accounting and audit scrutiny may increase the cost of administering programs financed by earmarked revenue sources. For example, the District's Arena Fee guarantees a level of Sports Arena funding, which requires little annual legislative review. However, annual General Accounting Office (GAO) audits and a separate collection and accounting requirement increase administrative costs for the Arena Fee.

Discussion of Specific District of Columbia Earmarked Budget Items

Earmarking in the District of Columbia is best discussed in the context of state practices for at least two reasons. First, many of the earmarked revenue sources in the District of Columbia are taxes normally found at the state level. Secondly, there is more information available on state earmarking than for any other level of government. However, the state comparison does not tell the complete story, because the District currently fulfills the responsibilities of several different levels of government (state, county, city, school district).

Congressional and bondholder requirements have played a major role in shaping the current District earmarking. The general obligation bond earmarking, Convention Center earmarking, Arena earmarking and Federal Highway Trust Fund earmarking all are based on the desires of Congress, bondholders or the combination of the two. Congressional approval of the District's budget provides a vehicle for Congressional influence on earmarking. Bond counsel and rating agencies play a major role, because most District earmarked expenditures are bond financed.

The District of Columbia earmarks several revenue sources for a variety of budgetary purposes as discussed below. Tables 3 and 4 summarize earmarked revenue sources in the District of Columbia and the purpose for which such earmarking is used. 

Table 3 SUMMARY OF DISTRICT OF COLUMBIA EARMARKED REVENUES BY SOURCE (Dollar amounts in thousands of dollars)
FY 1996 
General Tax Category

Amount  Earmarked

Percent of  Revenue Source 

Percent of Total  Tax Revenues*

       
Real Property $404,100 64.7% 12.07%
General Sales  $221,500 47.4% 6.61%
Selective Sales ** $71,500 75.5% 2.14%
Franchise Tax $3,700 2.4% 0.11%
Other Taxes, Fees *** $73,800  100.0% 2.21%
TOTAL $774,600   23.14%
       

* Includes all taxes plus arena fee, motor fuel tax, parking meters, traffic fines and vehicle registration  ** Includes alcoholic beverage, cigarette, motor vehicle fuel, motor vehicle excise and hotel occupancy  *** Includes arena fee, parking meters, traffic fines and motor vehicle registration fees.

 

Table 4 DISTRICT OF COLUMBIA EARMARKED REVENUES BY PURPOSE (Dollar amounts in thousands)
Earmarking Purpose Revenue Source FY 1996 % of  
Total Revenue * 
       
GO Bond Payment Real Property (variable % of total) 404,100 12.07%
New Convention Center 1% Restaurant Sales Tax 11,300  
  2.5% Hotel Sales Tax 13,200  
  Corporate Surtax (0.2375%) 2,900  
  U.B. Surtax (0.2375%) 800  
  Hotel Occupancy (40% of total) 3,200  
  TOTAL - CONVENTION CENTER 31,400 0.94%
Convention Center Promotion Hotel Occupancy Tax (60% of total) 4,800 0.14%
Federal Highway Trust Fund Motor Vehicle Fuel Tax (100% of total) 31,800 0.95%
New Arena Construction  Arena Fee 9,400 0.28%
Washington Metropolitan Area 
Transit Authority
9.0% Restaurant Sales Tax 116,000  
  10.5% Hotel Sales Tax 61,000  
  12% Parking Sales Tax 20,000  
  Motor Vehicle Excise Tax (all) 31,700  
  Parking Meter Fees (all) 9,600  
  Traffic Fines (all) 37,800  
  Motor Vehicle Registration Fee 17,000  
  TOTAL - Washington Metropolitan 
Area Transit Authority
293,100 8.76%
GRAND TOTAL   774,600 23.14%
* Includes all general fund taxes plus Arena Fee, Motor Fuel Tax, Parking Meter Fees, Traffic Fines and Vehicle Registration Fees.

General Obligation Bonds

The District of Columbia is required by D.C. Code 47-331(a) to:

"provide for the annual levy of a special tax or charge, if the Council determines that such tax or charge is necessary . . . Such tax or charge shall be levied . . . in amounts . . . sufficient to pay the principal of and interest on such general obligation bonds as they become due and payable."

The provision was enacted by the Council to meet requirements related to payment of general obligation bonds. The Code requirement is satisfied by setting aside a portion of the real property tax sufficient to meet the District's semiannual bond payment plus an additional five percent to cover delinquencies. Real property tax payments are due March 31 and September 15 of each year. The District of Columbia repayment of general obligation bonds occurs in June and December of each year. The March 31 real property tax collections are used for the June bond repayment and the September 15 real property tax collections are used for the December bond repayment.

As indicated in Table 3, the earmarked portion of the real property tax was 64.7 percent in FY 1996. This percentage is set to grow to 75 percent in fiscal year 1998.(10) The 75 percent earmarking in fiscal year 1998 compares to 46 percent as recently as fiscal year 1993. This rising percentage is due to the decline in the real property tax base over the last five years and a growing level of bond payments. If current trends continue another revenue source may be required to be earmarked to cover the general obligation bond payments in the near future.

Real property tax earmarking has changed the way in which taxpayers make real property tax payments. Beginning in FY 1995 all real property tax payments must be mailed to the lockbox bank (currently First Union) or taxpayers could pay in person at the First Union Bank. The first year of this procedure was difficult for some District of Columbia taxpayers who were accustomed to bringing real property tax payments to a cashier at One Judiciary Square.

Surplus funds collected for bond repayment in one year can be used to reduce the required payment for a subsequent year. This procedure used between the December and June payments eliminates the build up of excess funds in the bond repayment account and ensures that the real property tax earmarking is providing no more than the required amount of revenue. A second procedure used by the District's Treasurer is to "sweep" the account each August and return unused monies to the general fund.

Washington Metropolitan Area Transit Authority

The Washington Metropolitan Area Transit Authority (WMATA) provides mass transit for the District of Columbia and surrounding jurisdictions. Each jurisdiction within WMATA charges fares and contributes local revenues to fund WMATA. The agreement to use federal funds to assist in mass transit in the Washington D.C. metropolitan area requires each jurisdiction to allocate "stable and reliable" sources of revenue to pay for operating charges and the bond sinking fund. D.C. Code 1-2466 requires the District of Columbia to allocate the following general fund revenues to the "Metrorail/Metrobus Account". 

Motor vehicle excise tax
parking meter fees
9% sales tax on restaurant meals
10.5% sales tax on hotel/motel rooms 
12% sales tax on commercial parking services
motor vehicle registration fee
traffic fines

These revenues are allocated by the District of Columbia to WMATA along with grant revenues provided pursuant to the Urban Mass Transportation Act of 1964 to fund the Metrorail and Metrobus systems. D.C. Code 1-2466(e)(3) provides that funds not allocated to any other expenditures listed shall revert to the general fund. This guarantees that only the amount needed for the purposes enumerated is allocated from the above revenue sources. The earmarked FY 1996 revenue sources including grant funds accounted for $337.6 million.(11) Actual funds required for the account were less than $200 million. Despite the reversion of unused funds to the general fund, the "allocation" of the above revenue sources appears to prohibit other potential earmarked uses for these revenue sources. There is some disagreement within the District Controller's Office whether other earmarking is prohibited by the "allocating" of these revenue sources. D.C. Code 1-2466© also provides that personal property taxes are included as a backup funding source if "necessary to cover additional expenditures...". To this point the personal property tax revenues have not been needed.

The allocation of revenue sources to WMATA became an issue when the new Convention Center funding was being discussed. The allocation of hotel and restaurant sales taxes to WMATA made it more difficult to write the legislation earmarking a portion of revenues from the same sales tax for the new Convention Center. It was necessary to split the earmarking of the sales tax between WMATA and the new Convention Center. The restaurant sales tax is split with 9 percent earmarked for WMATA and 1 percent for the Convention Center. Similarly the hotel sales tax is divided with 10.5 percent earmarked for WMATA and 2.5 percent for the Convention Center.

Convention Center Fund

District of Columbia Code 9-809 provides for construction of a new Convention Center in the District of Columbia to be funded partially by a series of earmarked revenue sources. The new Convention Center proposed for the Franklin Square site will be funded in part by the following earmarked tax sources: 

1% sales tax on restaurant meals
2.5% sales tax on hotel/motel rooms
2.5% surtax on the 9.5% corporate franchise tax (0.2375% effective rate) 
2.5% surtax on the 9.5% unincorporated business franchise tax (0.2375% effective rate) 
40% of the $1.50 hotel occupancy tax 

The D.C. Code provides that the amount to be earmarked each month from sales tax and franchise tax collections may be determined based on a formula. This is an acknowledgment that it is not always simple to administer earmarking provisions. Because the District of Columbia sales tax has five different rates, any other approach is very complex. A similar issue occurs with regard to the franchise tax, where taxpayers file returns once a year, although collections occur quarterly. Absent a formula approach monies from the franchise tax would only be available when a taxpayer files an annual return.

D.C. Code 9-814(a) provides that if Washington Convention Center Authority "...balance of cash and investments ...exceeds the balance of current liabilities and reserves, the excess shall be transferred, in cash, to the General Fund of the District". The determination of these balances is the responsibility of the Washington Convention Center Authority. To date no monies have been returned to the general fund from the Convention Center Authority.

The total revenues collected for FY 1996 for the new Convention Center based on data from the Office of Tax and Revenue were $31.4 million. Table 4 provides a breakdown of these amounts by revenue source. Over 75 percent of the Convention Center revenues come from the restaurant and hotel sales taxes with only about 12 percent from the franchise surtaxes.

Section 305(b) of D.C. Law 10-188, approved August 2, 1994, provides that if the District of Columbia Auditor certifies that,

"projected revenues from the [earmarked] taxes are insufficient to meet projected expenditure and reserve requirements of the [Washington Convention Center] Authority for the upcoming fiscal year, the Mayor shall impose a surtax, to become effective on or before October of the upcoming year on each of those taxes dedicated to the Authority, excluding the tax on sales of restaurant meals and alcoholic beverages, ... equal to the pro rata share of the difference between [projected expenditures and revenues]" 

To this point in time the D.C. Auditor has not made such a determination. However there are serious administrative difficulties inherent in such a provision. If Convention Center costs escalate and additional funds are needed from the earmarked taxes, it is conceivable that the District could have different sales tax rates each year and different franchise tax rates each month. Due to the different fiscal years for corporations and unincorporated businesses, any change in the franchise tax rate must be allocated from the effective date for each different fiscal year period. The sales tax difficulties would arise from the difficulties of administering additional tax rates above the five already included in the sales tax return. Taxpayers would experience more difficulty in complying with District sales and franchise tax laws should such tax rate changes be made.

New Sports Arena

Chapter 27A of Title 45 of the District of Columbia Code provides for a Public Safety Fee (now Arena Fee) to finance site acquisition and development costs for the new Sports Arena. The Public Safety Fee was originally proposed as a general fund financing source. However, after one year the name was changed to the Arena Fee and was earmarked 100 percent for the new Sports Arena. The Arena Fee is a tiered flat rate tax based on a business taxpayer's District gross receipts. There are seven gross receipts categories with flat rates ranging from $25 for companies with gross receipts between $0 and $200,000 to $8,400 for companies with gross receipts in excess of $15 million. Table 5 illustrates the rate structure of the Arena Fee.

By law the Arena Fee rates are administratively adjusted if it is determined that the collections from a subsequent year will not be sufficient to provide $9 million. The rates may also be adjusted to make up for a shortfall in the prior year. The law provides that by December 1 of each year a certification is required that the Arena Fee will generate at least $9 million in the subsequent year. If such certification cannot be made on the basis of current rates, then the rates are changed so that $9 million will be collected in the subsequent year plus make up the prior year's shortfalls. This requirement sets a lower boundary on annual Arena Fee revenues. There is no provision to set an upper limit on annual Arena Fee revenues.

The Arena Fee is collected annually on or before June 15. As noted in Table 4 collections for FY 1996 were slightly above $9 million.

Table 5 RATE STRUCTURE FOR ARENA FEE    District Gross Receipts Arena Fee

$0-200,000 $25
$200,001-500,000 $50
$500,001-$1,000,000 $100
$1,000,001-$3,000,000 $825
$3,000,001-$10,000,000 $2,500
$10,000,001-$15,000,000 $5,000
Over $15,000,000 $8,400

NOTE: District gross receipts represent receipts allocated or apportioned to the District of Columbia.

Convention Center Promotion Activities

Sixty percent of the hotel occupancy tax is earmarked for the purpose of promoting Washington Convention Center Authority activities in the District of Columbia. Activities include promoting conventions and tourism in the District of Columbia. The hotel occupancy tax is imposed at a rate of $1.50 per room per night and is collected monthly. FY 1996 revenues earmarked for promotional activities were $4.8 million. Funds for the current fiscal year are earmarked for promotional activities based on the estimated revenues for the hotel occupancy tax.

There are three different organizations which receive these earmarked funds. The Washington Convention and Visitors Association receives 50% of the amount earmarked, the Mayor's Committee to Promote Washington receives 37.5% and the remainder (12.5%) goes to the Washington Convention Center Authority for advertising and promotion.

The use of these earmarked funds is less specific than that for other District of Columbia earmarking. The purpose of the earmarking is intended to be closely related to the industry paying the tax. Hotel owners will benefit to the extent that activities of the three organizations cited above can attract tourists to Washington.

Federal Highway Trust Fund

Public Law 104-21, the "District of Columbia Emergency Highway Relief Act", signed August 4, 1995, requires that the District of Columbia motor vehicle fuel tax be deposited into

"a dedicated highway fund to be comprised, at a minimum, of amounts equivalent to receipts from motor fuel taxes and, if necessary, motor vehicle taxes and fees collected by the District of Columbia to pay in accordance with this section the cost-sharing requirements established under title 23, United States Code and to repay the United States for increased Federal shares of eligible projects paid pursuant to section 2(a). The fund shall be separate from the general fund of the District of Columbia."

This earmarking is imposed by the federal government to ensure that the District is able to a) cover the matching share of federal funds on an ongoing basis and b) to reimburse the federal government for waiving certain local share requirements for District highway projects initiated between August 3, 1995 and October 1, 1996. The District of Columbia enacted the appropriate legislation to implement the earmarking and the motor fuel tax is now dedicated to the Federal Highway Trust Fund.

These actions removed the motor fuel tax as one of the earmarked revenue sources for WMATA. Prior to this action the entire motor fuel tax was allocated to WMATA.

According to federal and District law, excess dollars from the motor fuel earmarking are reimbursed and can be used for local streets and transportation needs, which are not eligible for federal aid. Prior to this earmarking the District was one of only three state jurisdictions without a highway trust fund for matching federal transportation monies.

This earmarking results in an increased level of administrative scrutiny for the motor vehicle fuel tax. The federal legislation noted above calls for annual audits of the motor fuel tax monies and an annual report by the General Accounting Office. These audits consume staff time and resources within the Office of Tax and Revenue and the Department of Public Works.


  POLICY ISSUES CONCERNING EARMARKING IN THE DISTRICT OF COLUMBIA

District of Columbia earmarking is more prevalent than would be assumed at first glance. Figure 1 (page A-2) indicates graphically that 23 percent of District of Columbia tax revenues are earmarked for several different purposes. The 23 percent does not include earmarking of nontax revenues such as solid waste disposal "tipping fees", which are earmarked for recycling costs. It also does not include the newly created business improvement districts (BID's) within the District. These districts are created as a result of business tenant activity and are designed to allow business tenants to tax themselves to create amenities within a specific business area. District of Columbia tax earmarking is primarily a response to Congressional and bondholder concerns. Earmarked tax sources for general obligation bonds, Convention Center funding, Arena site acquisition costs, federal highway funds and the WMATA fund are at the behest of Congress or bondholders. The District's options are limited with regard to such uses of earmarked funds.

Despite these limitations, the Tax Revision Commission has several earmarking options that can be explored as the District approaches the twenty-first century. Some of the Commission's options and examples of related specific issues are noted below.

ISSUE: WHAT SHOULD BE THE DISTRICT'S ATTITUDE TOWARD EARMARKING?

OPTION 1: Maintain Current System, But Discourage Additional Earmarking.

Current District earmarking funds specific programs or expenditures which are well-defined. Of the District's three largest tax sources, real property tax is 75 percent earmarked and sales and use tax is almost 50 percent earmarked (see Table 3). The largest tax source, the individual income tax, is not earmarked at all. As the percentage of earmarked real property tax increases, pressure will build to provide a second earmarked revenue source for general obligation bond payments. Convention Center earmarking may also need to be increased as expected costs rise. One way to address these issues without increasing overall earmarking is to reduce the amount of tax and other revenues earmarked for the WMATA fund. As much as $150 million in revenues earmarked for WMATA appear not be needed. Additional earmarking for other expenditure purposes should not be attempted until current patterns of earmarked revenues and expenditures are better understood.

OPTION 2: Expand earmarking beyond current levels to fund other needed programs.

Many local jurisdictions earmark revenue sources for school funding and other high priority budget needs. The District of Columbia should look to stabilize funding for these high priority items by earmarking stable revenue sources for their use. The city of Philadelphia, for example, earmarks its individual income tax for school funding. Earmarking "important" budget items emphasizes their importance to the community. There may be new projects and expenditures that individuals and businesses are willing to pay for with increased or new taxes. The Business Improvement District (BID) is an example of a self-assessed tax that is to be used for augmented public safety and other purposes as determined by the tenants of the business districts.

Increased earmarking within the District of Columbia could act as a mechanism to funnel more money to the most important community needs.

OPTION 3: Reduce the District's Reliance on Earmarking as Much as Possible.

Earmarking reduces budget options available to the citizens of the District of Columbia. Twenty-three percent of the District's current tax revenues are not available to fund general fund budget needs due to earmarking. A first step in reducing the reliance on earmarking would be to ensure that the earmarked revenue source is at or close to the required expenditure need. The WMATA earmarking in which revenues are $150 million above expenditure needs is an example of one problem in this area. Explicit annual and lifetime caps may need to be placed on Arena and Convention Center earmarked revenues. Earmarking for general obligation bonds and other future bond issues are more difficult to reduce. These earmarked revenue sources are not strong candidates for change in the short-term. Reduced reliance on future bond financing may be one way to reduce earmarking in the District of Columbia. 

ISSUE: SHOULD ACTION BE TAKEN TO ENSURE THAT DISTRICT CITIZENS HAVE BETTER INFORMATION CONCERNING EARMARKED REVENUES?

The Tax Revision Commission may wish to address concerns about the lack of public knowledge about District of Columbia earmarking. It is likely that very few District of Columbia citizens know that 75 percent of their FY 1998 real property tax payments will be used to pay general obligation debt. Different options to address this situation are presented below.

OPTION 1: Change Budget Presentation to Clarify Earmarked Revenue Sources.

The current Budget of the District of Columbia does not separate the earmarked portion of tax revenues from that part which is available for general expenditures. The budget document should make this apparent and should discuss the earmarking of each of the major tax revenue sources. Such clarification would be a useful tool for citizens, policy makers and others interested in the District's financial well-being.

OPTION 2: Require Annual Report.

An annual report detailing the extent of earmarking within the District of Columbia could be used to disseminate information to policy makers and the public. Such a report could be structured to examine earmarking trends within the District of Columbia. The proposed report could be required as part of the budget process. An examination of earmarking issues annually could be a useful tool in questions of tax policy and budgetary issues. The report could also be used as a benchmark to determine the District's earmarking compared to other states and municipal jurisdictions.

OPTION 3: Keep Things the Way They Are.

Currently, there is no attempt to provide information to the public or to policy makers concerning the extent of earmarking of District of Columbia tax sources. The status quo has worked in the past. It is possible that earmarking reports and general knowledge will inspire other interests to request more revenue sources be provided for favorite programs. Up to the present time, earmarking of tax sources has been primarily in response to Congressional and/or bondholder direction.


CONCLUSION

There is more earmarking within the District of Columbia budget than would appear from first glance. A graphical presentation of the extent of District earmarking is presented in Figure 1. About 23 percent of District tax revenues are earmarked for several different purposes. This does not include earmarking for such purposes as "tipping fees" to cover recycling costs within the solid waste disposal operations. Earmarking in the District is primarily for specific, well-defined budget purposes. In more than one case a specific dollar amount of revenue is earmarked, rather than a percentage of a revenue source. This approach ensures that the correct amount of revenue is earmarked. The District imposes a tax (Arena Fee) whose sole purpose is as an earmarked revenue source for an expenditure purpose (the new Sports Arena).

There are several ways the District could improve its current earmarking procedures. Ideally, earmarking should include a) an earmarked revenue source sufficient to fund the expenditure need including expected growth and b) be limited to the amount required for that budget need. These guidelines would suggest either a cap on the amount of earmarked revenue or a time limit (sunset) for earmarking of revenue sources. Should the District decide to earmark additional revenue sources for programs and expenditures these two rules should be incorporated. There are pressures within the District of Columbia to earmark additional revenue sources other than tax sources. Automation improvements and more operational funding are needed within many District of Columbia agencies. Some of the agencies have suggested that retention of certain amounts of administered fees and charges would be an appropriate source of financing for these needs. There are legislative proposals to allow District agencies to retain revenues above certain baseline amounts. Fees and fines above a certain threshold would be earmarked for agency use, presumably for automation and operational improvements. Such proposals should be seriously considered. However a plan of action needs to be provided before actual expenditures are approved from an earmarked revenue source. Many District agencies face a combination of inadequate funding and difficulty in budgeting for capital needs. Earmarking may be a way to avoid the difficult task of making a case for increased funding levels from the general fund.

Earmarking of revenues within a jurisdiction such as the District of Columbia can serve a budgetary purpose if applied judiciously. There are certain situations and circumstances in which earmarking is appropriate. Single purpose projects and bond funding fall into this category. It does not appear that the District's practices are out of line with those of other states. For the most part District earmarking is carefully applied with safeguards to ensure that the appropriate amount of revenue is earmarked. Much of the District's current earmarking is the result of Congressional or bondholder requirements.

The issues identified for the consideration of the Tax Revision Commission can have a direct impact on the citizens of the District of Columbia. Earmarking and the "technical issues" surrounding the practice can affect citizens in several ways. For example, the practice of earmarking reduces budget options by declaring 23% of the revenue stream "off limits" when searching for funding sources. Earmarking can result in new taxes, such as the Arena Fee. The administration of earmarking can result in unlegislated tax increases and increased taxpayer complexity. Earmarking can also be used to ensure the District's access to the bond market by earmarking a stable revenue source for bond repayment.


1. Arturo Perez and Ronald Snell, "Earmarking State Taxes, Third Edition" (Denver, Colorado: National Conference of State Legislatures) 1995, p. 3

2. Arturo Perez and Ronald Snell, ibid.

3. Arturo Perez and Ronald Snell, ibid.

4. Robert D. Ebel, Editor, "A Fiscal Agenda for Nevada" (University of Nevada Press, Reno, Nevada) 1990 page 413.

5. Arturo Perez and Ronald Snell, ibid. p. 61

6. Arturo Perez and Ronald Snell, ibid. pp. 5-6

7. James A. Maxwell, "Financing State and Local Governments, revised edition" (Brookings Institution, Washington, D.C.) 1969, p. 215

8. Gene Owens, Political Editor (Mobile Register) "The trust too easily taken" August 5, 1997

9. Gene Owens, ibid.

10. Conversations with Tax and Economic Policy Administration personnel indicate that the level of earmarking of real property taxes for general obligation bonds will reach 75 percent in fiscal year 1998.

11. District of Columbia Comprehensive Annual Financial Report, Year Ended September 30, 1996. P. 43


APPENDIX

Table 6 DISTRICT OF COLUMBIA EARMARKED REVENUES BY REVENUE SOURCE (Dollar amounts in thousands)
Revenue Source Earmarking Purpose FY 1996 % of Total *
       
Real Property Tax General Obligation Bond Repayment 404,100 12.07%
Restaurant Sales Tax (1%) New Convention Center 11,300 0.34%
Restaurant Sales Tax (9%) Washington Metropolitan Area Transit Authority 116,000 3.47%
Hotel Sales Tax (2.5%) New Convention Center 13,200 0.39%
Hotel Sales Tax (10.5%) Washington Metropolitan Area Transit Authority 61,000 1.82%
Parking Sales Tax Washington Metropolitan Area Transit Authority 20,000 0.60%
Motor Vehicle Fuel Tax Federal Highway Fund 31,800 0.95%
Motor Vehicle Excise Tax Washington Metropolitan Area Transit Authority 31,700 0.95%
Hotel Occupancy Tax New Convention Center 3,200 0.10%
Hotel Occupancy Tax Washington Convention Center Promotional Activities 4,800 0.14%
Corporate Franchise Surtax New Convention Center 2,900 0.09%
U.B. Franchise Surtax New Convention Center 800 0.02%
Arena Fee New Sports Arena 9,400 0.28%
Parking Meter Fees Washington Metropolitan Area Transit Authority 9,600 0.29%
Traffic Fines Washington Metropolitan Area Transit Authority 37,800 1.13%
Motor Vehicle Registration Fee Washington Metropolitan Area Transit Authority 17,000 0.51%
TOTAL   774,600 23.14%

 * Includes all taxes plus Arena Fee, Motor Fuel Tax, Parking Meter Fees, Traffic Fines and Vehicle Registration Fees.

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