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August 8,2011 The Honorable Kwame R. Brown Chairman Council of the District of Columbia 1350 Pennsylvania Avenue, NW, Suite 504 Washington, DC 20004 Dear Chairman Brown: Thank you for your August 3, 2011 letter wherein you reaffirm your commitment to working with me to restore the District's fund balance. While I do not want to engage in a back-andforth exchange of letters, I do feel there were some erroneous statements made in writing and to the media that could give District residents an incorrect impression. Thus, I wish to provide necessary clarification to those statements, so that the record is clear.
Clarification #1: I moved legislation as Council Chairman in June 2010 to create a framework for replenishing the fund balance. Therefore, the Council's designation of additional revenue was a continuation of the efforts I took as Council Chairman, but was by no means the first, only, or most significant step towards replenishing our fund balance.
I thought I would start by recounting the history of the legislation I moved forward as Council Chairman to establish the existing statutory framework for restoring the District's fund balance. As part of the Fiscal Year 2011 budget, I added a subtitle to Bill 18-731, the "Fiscal Year 2011 Budget Support Act of 2010" entitled the "Sustainable Capital Investment and Fund Balance Restoration Act of 20 I 0." I realized that something had to be done to maintain the confidence Wall Street has shown in the District of Columbia after the prior administration's overspending had depleted most of the City's reserves. I added this legislation to the Budget Support Act to create a legislative framework, which if followed, will ensure that the District moves forward in a fiscally prudent manner.
The fund balance portion of this legislation requires the Chief Financial Officer to deposit all undesignated end-of-year surplus funds into two newly created reserve accounts until the District achieves two months cash among its four reserve accounts. Two of these reserve accounts are the District's Congressionally-mandated Rainy Day Funds: the Emergency Cash Reserve (2%) and the Contingency Cash Reserve (4%). The two new accounts I created were the Fiscal Stabilization Reserve (2.34%) and the Cash Flow Reserve (8.33%). The Fiscal Stabilization Reserve was designed to provide flexibility if unforeseen spending pressures arise or revenue drops unexpectedly. The Cash Flow Reserve was designed to reduce the District's reliance on short-term borrowing, called Tax Revenue Anticipation Notes (TRANS) borrowing. These reserves would build up gradually over the next 5 to 10 years until, coupled with the federally-mandated Rainy Day funds, the District achieves the two months cash on hand, which is 16.67% of the District's operating budget. I modeled this provision after recommendations from the Government Finance Officers Association (GFOA). GFOA has recommended governments have two months cash as a best practice for governments to follow. D.C. Chief Financial Officer, Dr. Natwar Gandhi has also repeatedly emphasized this 2-month recommendation during testimony before the Council. We presented this approach to the bond rating agencies in February 2011. The bond rating agencies lauded this approach to replenishing our fund balances. You were in attendance at each of those meetings, which is why I am puzzled by the statement in your August 3, 2011 letter in which you write, "1 feel compelled to note that if the Council had passed your proposal without revisions, we would be in the difficult position of explaining to the credit rating agencies why we were not taking any steps to rebuild the fund balance despite our standing commitment to do so." Clearly, there is a strategy in place to replenish the fund balance, and all end-of-year surplus funds will be deposited evenly into the Fiscal Stabilization Reserve and the Cash Flow Reserve as we committed. Clarification #2: The Council budgets did not set aside more funds than the Executive proposals for rebuilding the fund balance under any comparative version of the legislation. I read a number of quotes by you and another Councilmember in various media articles that stated that the Council somehow set aside more funds than my budget proposals for rebuilding the fund balance. I closed a $322.1 million budget gap and submitted a structurally balanced Fiscal Year 2012 budget to the Council on April 1, 2011 that required a series of very difficult cuts and revenue increases. Because of these difficult choices, the budget I sent to the Council on April 1, 2011 set aside no new dollars for rebuilding the fund balance. The Council obviously experienced similar problems from this tight budget, because the budget approved by the Council on May 26, 2011 set aside no additional dollars for rebuilding the fund balance. (Executive - $0; Council- $0)
Left unchanged, the Fiscal Year 2012 budget I proposed April 1,2011 would have deposited the entire $77 million in additional revenue certified by the Chief Financial Officer into the fund balance, $38.5 million to Fiscal Stabilization Reserve and $38.5 million to the Cash Flow Reserve at the end of the fiscal year via the "Sustainable Capital Investment and Fund Balance Restoration Act 0[2010." In its May 26,2011 budget, the Council decided to engage in contingent budgeting and allocate future revenue that had not been certified by the CFO. For June, this meant that the $77 million that was eventually certified was allocated as follows: $21.6 million to reverse positions that you had shifted from the operating budget to the capital budget, $27.7 million to the Cash Flow Reserve, and $27.7 to a list of expenditure priorities. I don't want to criticize the substance of what you did, because I actually agreed with the end result of this prioritization. But you should at least be cognizant that through your changes to my proposed budget; $49.3 million less was ultimately designated for the fund balance by law than would have occurred with my original proposal. (Executive - $ 77 million; Council - $27. 7 million) I supported the Council's balanced allocation of future revenue, with 50% of new revenue for important program expenditures and 50% to be deposited into the Cash Flow Reserve. I signed the Fiscal Year 2012 Budget Request Act, thereby committing myself and the District to deposit 50% of June and September revenue into the Cash Flow Reserve. Technical amendments to the budget were required in July before the budget could be sent to Congress. In my budget re-submission to the Council, I held firm in OUf commitment we made earlier, and kept the entire $27.7 million in the Cash Flow Reserve. Then, in a bill labeled the "Technical Clarification" Act, the Council passed an amendment that withdrew $13.4 million from the Cash Flow Reserve. (Executive - $27. 7 million; Council- $14.3 million) Therefore, under every scenario, the budget proposed by the Executive would have resulted in more dollars flowing into the fund balance, by law, than the equivalent budget approved by the Council. Clarification #3: Neither Dr. Gandhi nor I have ever suggested that an amount of $13.4 million will be the tipping point in a negative outlook or downgrade. In your August 3, 2011 letter to me you stated that, "The use of $13 million to permit a delayed implementation of the tax on interest earned on out -of-state bonds will not break the District's financial back, and any suggestion to the contrary is misleading District residents." First, neither Dr. Gandhi nor myself have ever suggested that the dollar amount of $13.4 million will be the important determining factor in whether the District receives a negative outlook or downgrade. I thought I had made this point clear in the two meetings I had with you Tuesday, August 2,2011.
To reiterate, both Dr. Gandhi and I feel that taking $13.4 million from the Cash Flow Reserve sends the wrong symbolic message that the District is not dedicated to keeping its financial commitments. This symbolism is critical to both our reputation and our ratings. When I proposed and the Council passed the 12% debt cap legislation and the "Sustainable Capital Investment and Fund Balance Restoration Act of 2010," what the bond rating agency analysts said to me both times was, if you propose something, then you need to be prepared to stick with what you proposed, because if you don't keep your commitment, we will never believe you when you make the promise again. Right now the commitment that the District will deposit all end of year funds into the reserve accounts is one of our most important arguments buttressing the District against a possible downgrade. One of those accounts, the Cash Flow Reserve, is a legislative lockbox for dollars that should only be used for cash flow purposes. For the Council to reserve 50% of newly certified revenue from June and September for the Cash Flow Reserve, and then change its mind in only a month and a half appears to be erratic, and does not portray the steady and finn approach that I believe we need to send to Wall Street when we make a commitment on fund balance. For the Council to take money out of the Cash Flow Reserve ... our "lockbox," gives the signal to Wall Street that the Council is willing to do it again. Therefore, the Council's action not only reverses its own commitment, it also undermines the far larger commitment that is made by the "Sustainable Capital Investment and FUnd Balance Restoration Act of 2010." To lose the credibility the District received from this legislation, is what I believe may be the tipping point between maintaining our rating versus a negative outlook or downgrade. Clarification #4: The Council was not "ambushed" this legislation, or "blindsided" by my pocket veto of
Perhaps the comments I have been most surprised by is that you and another Councilmember felt "ambushed" or "blindsided" by my pocket veto of this legislation. I wrote the Council on July 12, 2011. The bulk of my letter was to thank you for your leadership and partnership throughout the budget process and to speak in support of an amendment that we understood would be moved at the legislative meeting to replace the unfair retroactive income tax increase on bondholders with a far more progressive income tax rate increase on high-income earners. At the end of the letter, I also detailed my opposition to other rumored amendments, stating, "I am also aware of alternative amendments being discussed to use fund balance or to cut from the $30.9 million in funding needed to support critical FY 2012 programs ... These would not be proposals I would support." Immediately before the Council vote on the amendment that withdrew the money from the fund balance for the out-of-state bonds, Councilmember Vincent Orange read, on the dais, the two sentences from my letter opposing the amendment. Thus, every Councilmember was aware that I opposed this amendment. Consequently, given this experience and the foregoing information in the July 12m letter, I am surprised anyone was surprised at my position and veto.
Also statements have been made that I did this at the "11 III hour" or "in the dead of night." I elected to not sign the legislation, which is a pocket veto, instead of a traditional veto, because I did not want to be on record as vetoing clarifying amendments to the District's smokefree laws, which I strongly support, and which were unfortunately intertwined in the same bill. The Mayor has a certain amount of time to sign a bill, which by statute always ends at midnight on the last day of the review period. Thus, it is impossible to "not sign" a bill prior to this review period ending at midnight, and therefore, by statute, I am unable to "not sign" a bill even during the "11 til hour," it can occur only when the "11th hour" becomes the "12th hour." Finally, I met with you twice on Tuesday, August 2, 2011, to discuss my reasoning for the pocket veto and to hear your reasons why I might want to reconsider my stance. We met for a total of about 3 hours, thoroughly discussed and debated the relevant facts, but ultimately agreed we were in a different place on this issue. This occurred before the review period ended and the pocket veto occurred.
Clarification #5: I do not, nor ever have, supported retroactively taxing out-of-state
bondholders. I have gone on record probably at least a dozen times in my time as Ward 7 Councilmember, Council Chairman, and Mayor as not supporting a retroactive tax on District of Columbia bondholders. When I prepared my Fiscal Year 2012 budget, this is one of the options my budget team presented to me as a gap-closing solution, and I rejected it, and did not include it in my Fiscal Year 2012 budget I sent to the Council on April 1, 2011. In your proposed budget, you swapped the income tax rate increase I had proposed on higher income earners for an income tax increase on out -of-state bonds. I have stated repeatedly that I believe increasing the top tax rate on higher income earners to 8.9% is a far more equitable tax policy because it taxes individuals who are actively earning income. By way of example, for every $50,000 a person earned above the 8.5% rate level, they would pay just $200 in additional taxes. By contrast, a retroactive tax on out-of-state bonds taxes the investment income of persons, many of whom are retirees, and are not actively earning income. The higher-income earners tax has also had the benefit of a public hearing and vetting process. A poll conducted by the D.C. Fiscal Policy Institute demonstrated strong support by D.c. residents for the higher income earners tax. My experience at budget town hall meetings in all eight wards of the city also mirrors the findings of the poll, as residents, even those making over $200,000 annually, were almost universally supportive of this progressive tax increase. You were ultimately able to get the votes needed to swap my income tax increase on higher income earners with your income tax increase on bondholders. Since, I do not have line-itemveto power over the Budget Support Act, I would have had to veto the entire budget to stop the Council's retroactive bond tax. In a letter dated May 25,2011, in which I expressed my support for the overall budget, I wrote:
"In a $9 billion budget there will always be areas in which we disagree. I have stated publicly on many occasions that I continue to support my initial proposal to increase the top tax rate from 8.5% to 8.9% for income above $200,000. This modest increase has broad support throughout the District of Columbia, even among upper-income District residents who would be impacted by the tax. I continue to believe this proposal is a more progressive and equitable tax policy than a tax on out-of-state bonds. The higher income earners' tax increase taxes persons earning income in excess of $200,000, whereas a tax on bonds may adversely impact the investment portfolio of retirees who could be on a fixed income. I also believe the income tax increase has received a full public vetting during this budget cycle, while a tax on bonds has not. If the Council ultimately decides to swap the bond tax increase for the income tax increase, it is not a change that would prevent me from supporting the budget." Just prior to the July 12, 2011 legislative meeting, I thought I had received news of a possible change in sentiment. I learned that Councilmember Cheh was planning to propose an amendment to swap the retroactive portion of the out-of-state bond tax with an income tax rate increase on higher-income earners for dollars earned over $350,000. I immediately drafted a letter pledging my support for this amendment and urged other Councilmembers to support Councilmember Cheh, stating: "Additionally, I have learned of an amendment being offered by Councilmember Mary Cheh that substitutes the retroactive portion of the Council's income tax increase on out-of-state bonds with a proposal to increase the top income tax rate to 8.9% for earners making over $350,000 and to make the out-of-state bonds taxable going forward only. I want to speak strongly in support of this amendment. I proposed, and continue to support an 8.9% tax rate for high income earners at the $200,000 level. A top rate set at $40,000 is not progressive tax policy. I continue to believe increasing the top rate is a more progressive and equitable tax policy than a retroactive tax on out-of-state bonds for several reasons: (1) it taxes individuals who are actively earning income versus targeting pension investments for persons who may be on a fixed income; (2) it has broad public support, as was demonstrated by a poll administered by the D.C. Fiscal Policy Institute; and (3) the income tax increase has received a full public vetting during this budget cycle." From the vote count we did on the legislation, I believed the votes were there to pass this amendment. However, it was not moved, and an amendment was moved in its place that I was on record as not supporting.
The suggestion has been made that by delaying the bond tax for one year, the Council would have eliminated the retroactivity associated with it, because people would have had time to reorganize their investment portfolios to swap out-of-state bonds with other investment instruments. I think anyone who invests in bonds knows that it is not simple or inexpensive to rework one's investment portfolio, even with one year's notice. Out-of-state bondholders bought these bonds with the understanding that they would be tax exempt. Some even bought these bonds during a time when the District's bond ratings made it impossible for them to invest in District bonds. Therefore, even with a one year delay, I do not believe the Council solved the unfairness of retroactivity, because the Council is still proposing to tax bonds that were purchased when the law stated the bonds were tax exempt. Despite my continued belief that a retroactive tax on bondholders is unfair, I was not willing to sign legislation that withdraws committed dollars from the Cash Flow Reserve to provide a one-year solution to a retroactivity problem that is clearly ongoing, particularly when I believe the withdrawal of these funds threatens the District's bond ratings. I do want to go on record supporting removing the tax exemption on out-of-state bonds on a prospective basis, meaning that the tax would only apply to bond offerings purchased after the effective date of the legislation imposing the tax. I believe this will incentivize residents to invest in District bonds. When combined with a tax rate increase for higher income earners of 0.4%, beginning at $350,000, these proposals will provide sufficient funds to eliminate the retroactive tax on our bondholders. Conclusion Thank you for your leadership and partnership throughout our work on the Fiscal Year 2012 budget. I don't want one issue, over which we disagree, to distract from the fact that the District has approved its first structurally balanced budget in four years, has remained within the 12% debt cap, and has held firm in its statutory commitment to rebuild the District's fund balance using end-of-year surpluses. Those should be the headlines that we read in the newspaper, talk about with District residents, and use to make our case with the rating agencies that the District's finances remain strong and are on an upward trajectory. I look forward to continuing to work with you and the Council on our shared goal of rebuilding the District's fund balance, and hope that this debate only strengthens our collective resolve to strengthen the District's financial health.
Vincent C. Gray Mayor cc: Members of the Council Chief Financial Officer