GOVERNMENT OF THE DISTRICT OF COLUMBIA OFFICE OF THE CHIEF FINANCIAL OFFICER Jeffrey S. DeWitt Chief Financial Officer February 26, 2021 The Honorable Muriel Bowser Mayor of the District of Columbia 1350 Pennsylvania Avenue, NW, Suite 306 Washington, DC 20004 The Honorable Phil Mendelson Chairman Council of the District of Columbia 1350 Pennsylvania Avenue, NW, Suite 504 Washington, DC 20004 Re: February 2021 Revenue Estimates Dear Mayor Bowser and Chairman Mendelson: This letter certifies the revenue estimate for the FY 2022 – FY 2025 District of Columbia Budget and Financial Plan. The revised estimate increases the current FY 2021 – FY 2024 financial plan revenue by $227 million. This, combined with prior revisions, leaves a financial plan deficit of $235 million to be addressed. Revenue for FY 2021 is $141.8 million (-1.7 percent) below the FY 2020 revenue level and grows $387.5 million (+4.8 percent) in FY 2022. Revenue is expected to return to the FY 2019 level of $8.3 billion in FY 2022 as vaccines are deployed and the economy recovers. February Revenue Estimate Compared to FY 2021 Budgeted Revenue Actual Estimated Projected Local Source, General Fund Revenue Estimate ($M) FY 2020 FY 2021 FY 2022 FY 2023 FY 2024 FY 2025 FY 2021 BUDGETED REVENUE 8,037.7 8,491.0 8,762.2 9,069.4 September revision -211.9 -209.7 -190 -170.4 December revision* 68.4 56.9 101.7 93.2 February revision* 113.8 57.3 36.7 19.0 Total revisions to budgeted revenue -29.7 -95.5 -51.6 -58.2 February 2021 Revenue Estimate 8,149.8 8,008.0 8,395.5 8,710.6 9,011.2 9,297.4 Revenue Change from Previous Year Amount (165.0) (141.8) 387.5 315.1 300.6 286.2 Year-Over Year Percent Change -2.0% -1.7% 4.8% 3.8% 3.5% 3.2% * December and February revisions largely related to better than expected individual and business income taxes for the non- COVID impacted sectors of the economy and the impact of federal relief. John A. Wilson Building * 1350 Pennsylvania Avenue, NW * Suite 203 * Washington, DC 20004 Phone: (202) 727-2476 * Fax: (202) 727-1643 * www.cfo.dc.gov February 2021 Revenue Estimate February 26, 2021 Page 2 Our assumptions about the re-opening timeline are unchanged, but the large injection of federal spending is expected to accelerate the recovery once the re-opening phases occur. On the downside, the COVID-19 impact on commercial real property markets will be a drag on revenue growth in FY 2022 and beyond. Lower income from hotel, apartment, and office properties in calendar year 2020 are reflected in preliminary real property assessments to be sent out in March and will be the basis for real property tax revenues in FY 2022. Beyond FY 2022, greater levels of remote work will limit growth in the value of commercial office properties. The table below shows the re-opening timeline assumptions underlying the estimate. We expect Phase II of ReOpenDC to maintain restrictions on economic activity until Spring 2021. Fortunately, the availability and deployment of at least two vaccines is expected to accelerate the recovery in the second half of the fiscal year and slightly improve the overall economic outlook for FY 2021, moving the District to Phase IV of ReOpenDC when most restrictions are lifted. Re-open assumptions underlying estimate Winter 2020/2021 Spring/Summer 2021 Fall 2021 Phase II Phase III Phase IV • Business capacity restricted • Business capacity 75% (10ppl per 1000 sq. ft.) • Public health • Restaurants: limited indoor dining • Restaurants: indoor dining allowed 50% restrictions lifted • Groups < 25ppl • Bars/nightclubs: 50% (5 ppl per 1000 sq. ft.) • Libraries open with safeguards • Groups < 250 ppl • Telework encouraged but in-office up to 50% Note: adapted from ReOpenDC phased restrictions We expect the economy to continue its current path of recovery. The federal relief package enacted in December 2020 has improved the economic outlook. Also, the American Rescue Plan Act, now moving through Congress will further improve the outlook, particularly for FY 2021. The enhanced unemployment insurance, extended Paycheck Protection Program (PPP), additional economic impact payments, and substantial state government assistance will prepare the economy for the pent-up demand for restaurants, retail, entertainment, and travel when the pandemic is finally brought under control. The pandemic significantly changed the trajectory of District local fund revenue. In the February 2020 estimate, growth was projected to be 1.7 percent following a strong FY 2019. However, the pandemic economy resulted in a contraction of 2 percent in FY 2020. Cumulatively, over the FY 2021-FY 2024 financial plan, District revenue was $2.6 billion below the pre-COVID-19 projections. Revenue Highlights Because of the pandemic, the performance of District revenue sources was affected by developments in three areas: • Pandemic Public Health Restrictions. Revenue sources, such as sales and deed taxes and licenses and fines which are tied to in-person customers, commuters or occupied offices, February 2021 Revenue Estimate February 26, 2021 Page 3 were most affected by the business activity restrictions required to control the spread of COVID-19. These taxes combined declined more than 20 percent in FY 2020 and are expected to decline further in FY 2021. With the federal relief package being considered, and assumed in this estimate, we do not expect a change in the re-open schedule but we do expect a stronger “return to “normal” as grants and relief funds keep families and businesses whole until they can go out again and reopen. • Business support and remote work. Conversely, revenue from individual and business income taxes, one-third of 2019 general fund revenue, has not been disrupted. In the case of business income taxes, the revenue outlook has exceeded the pre-COVID-19 projection because of the ability to transition to telework for many employers, business relief, the Federal reserve monetary policy, and a soaring stock market. • Office and residential space. The transition to remote work has allowed a significant share of employment in the District to remain unaffected by the pandemic, but it could also lead to shrinking demand for office space and changes in residential preferences. Reductions in office space use and preferences for residences farther away from places of work could have a deleterious effect on the outlook for real property taxes collected from large office and multifamily properties as well as deed taxes from the sale of those assets. Real property tax Real property tax revenue is revised upward by $64.4 million in FY 2021 to reflect final bills mailed to taxpayers in February for March 2021 collection. However, real property tax revenue was revised downward by $40.1 million in FY 2022, $80.2 million in FY 2023, and $91.5 million in FY 2024. These downward revisions reflect the pandemic’s impact on assessments that will be mailed in March, as well as forecasted trends in office and apartment leasing markets gleaned from extensive research and discussions with real estate professionals. Large office building value, which comprise 35 percent of all District assessed value (and 45 percent of tax liability due to the higher commercial tax rate) is forecasted to grow less than 1 percent in FY 2021 and contract by 9.7 percent in FY 2022 before stabilizing. Sales tax Sales tax collections continue to be impacted by the pandemic public health restrictions limiting retail and hospitality activities in the District. After a decline of 23.5 percent in FY 2020, gross sales taxes before earmarks is forecasted to decline 8.9 percent in FY 2021. However, the significant federal relief and grants to District businesses should result in a stronger recovery in FY 2022, and sales taxes, driven by restaurant, hotels, and entertainment venues re-opening, is expected to grow 33 percent. Sales tax revenue recovers to the 2019 level in FY 2023. Income taxes Both individual and business income tax revenues have been revised upward. The strong stock market, the ability to work remotely for many employees, and significant federal relief support individual income tax revenue, which is expected to grow 3.1 percent in FY 2021, and 3.4 percent in FY 2022. By FY 2023, individual income tax revenue growth returns to trend of about 4.5 percent. February 2021 Revenue Estimate February 26, 2021 Page 4 Corporate franchise revenue in FY 2021 is expected to decline from FY 2020, not because of corporate profit weakness, but because the FY 2020 revenue included significant one-time prior year collections. Corporate franchise revenue is expected to grow 2.8 percent in FY 2022 and 3.5 percent in FY 2023. Unincorporated business franchise tax revenue will be positively impacted by federal and District relief programs aimed at supporting rent and lease payments, but collections are expected to decline in FY 2021 despite an upward revision of $11.6 million. In FY 2022, unincorporated franchise tax is expected to grow 1.2 percent and about 1.5 percent through FY 2025. The support provided by federal and District relief offsets the underlying weakness in apartment and office leasing that make up a significant part of the unincorporated business taxable activity. Deed taxes Deed taxes for residential properties remain strong as sales of single family homes, particularly high-value homes, have been strong since Summer 2020. However, office and multifamily sales were weak and total deed recordation and transfer taxes declined 19.3 percent in FY 2020. Collections will grow modestly at 1 percent in FY 2021 but don’t recover to 2019 levels until FY 2023.