STATE AND LOCAL FISCAL ASSISTANCE ACT OF 1972

TUESDAY, MARCH 25, 1980

HOUSE OF REPRESENTATIVES,

INTERGOVERNMENTAL RELATIONS

AND HUMAN RESOURCES SUBCOMMITTEE

OF THE COMMITTEE ON GOVERNMENT OPERATIONS,

Washington, D.C.

The subcommittee met, pursuant to notice, at 9:35 a.m., in room 2247, Rayburn House Office Building, Hon. L. H. Fountain (chairman of the subcommittee) presiding.

Present: Representatives L. H. Fountain, Ted Weiss, John W. Wydler, Clarence J. Brown, and Olympia J. Snowe.

Also present: Delphis C. Goldberg, professional staff member; Pamela H. Welch, secretary; and John Faso, minority professional staff, Committee on Government Operations.

Mr. FOUNTAIN. The subcommittee will come to order. Let the record show that a quorum is present for the purpose of taking testimony. The subcommittee will continue taking testimony this morning on legislation to reauthorize the general revenue-sharing program which expires on September 30 of this year.

It is a great pleasure to welcome as our first witness, our good friend and an able and competent public servant, Elmer Staats, the Comptroller General of the United States. His counsel has always been helpful to this committee, in fact, to all of the committees in Congress. We look forward to hearing his testimony today.

Before proceeding, would you please introduce for the record the members of your staff who are accompanying you.

STATEMENT OF ELMER B. STAATS, COMPTROLLER GENERAL OF THE UNITED STATES, U.S. GENERAL ACCOUNTING OFFICE

Mr. STAATS. Thank you, Mr. Chairman. To my immediate right is Mr. Bill Thurman, who is in charge of our work in intergovernmental relations. To his right is Mr. Correira, on his staff. To my left are Mr. Jarman and Mr. Fastrup. They will all join with me in answering questions this morning.

I have, Mr. Chairman, a longer statement and a shorter statement. I will read the shorter statement.

Mr. FOUNTAIN. I read your longer statement last night. It will become a part of the record.

Mr. STAATS. Whether State governments should continue to receive revenue-sharing funds has become a central and controversial issue

surrounding renewal of the program. To assist the Congress in considering the issue, we visited nine States to assess the impact if State governments were eliminated from the program.

To put revenue-sharing assistance to the States in some perspective, it should be noted that in fiscal year 1978, revenue-sharing receipts constituted about 1 percent of total State revenues.

Because the fiscal condition of the States provides insight into both the extent of their continued need for revenue-sharing assistance and their capacity for absorbing its loss, we examined the fiscal health of each of the nine States.

As shown in attachment 1 to my complete statement, State officials' perceptions of the fiscal health of their States ranged from reasonable to excellent. Our analysis of revenue, expenditure, and surplus trends and other indicators of fiscal condition generally supported all nine States' perception of sound health. There were, however, signs of a leveling off of fiscal growth.

For example, while all the States experienced revenue growth, since fiscal year 1977, all have enacted tax cuts or other tax relief measures. Such tax actions parallel the national trend. According to the Tax Foundation, in calendar year 1979, 33 States enacted some kind of tax relief, and the net tax relief nationwide amounted to at least $2 billion. Attachment 2 to my complete statement identifies general operating fund revenues, expenditures, and surplus balances for the nine States visited for fiscal years 1974 through 1980.

While most State officials could not predict with any certainty where the impact of losing revenue sharing would be felt, officials of five States told us they would expect no reduction or minimal reduction in State aid to local governments. Officials of the four remaining States stated that there would probably be some reductions in State aid.

State officials also mentioned other potential effects resulting from the loss of revenue sharing, such as cuts in State services, tax increases, and reductions in States' participation in Federal grant programs because of their inability to meet Federal matching or maintenanceof-effort requirements. However, no strong pattern developed and most of these other impacts were considered only possibilities.

Difficulties would obviously be created for the State and local sector should the Congress decide to eliminate State governments from the revenue-sharing program. It would appear, however, that the sound current and projected short term fiscal health of most of the States we visited would enable them to withstand the loss of revenue-sharing funds.

Views of executive and legislative officials in all but two States supported this conclusion. However, officials were almost unanimous in the view that State governments should be retained in the revenue sharing program.

In addition to noting that the States make effective use of revenuesharing funds, they pointed to the program's flexibility, lack of redtape, and lower administrative costs which act as a counterbalance to the rigid requirements of the categorical grant programs that still dominate the assistance system.

Because of the extensive concern about ways to better target funds to local governments, we are currently analyzing the distributional

patterns produced by the present revenue-sharing formula. We think the formula elements of population, income, and tax effort provide a reasonable approach for allocating funds.

However, various formula constraints and allocation procedures lead to widespread inequities which appear correctable. By inequities we mean that similar governments within a State have wide disparities in per capita revenue-sharing payments.

An advantage of the formula is the interaction of the income and tax effort factors. The formula rewards on a per capita basis lower income local governments and those governments which make the greatest effort to help themselves through higher tax effort.

In our ongoing study of the revenue-sharing formula, we refer to this interaction, or combined effect, of income and tax effort factors as fiscal effort. If the formula worked equitably, governments with the same fiscal effort would get the same per capita revenue-sharing payments.

Our analyses show, however, that there are widespread inequities in per capita revenue-sharing payments to governments within a State which have similar fiscal efforts.

For illustrative purposes we can compare two towns in one State that have populations of 8,000 and nearly identical fiscal efforts. Yet, in 1979 one town received $19.92 per person compared to $13.41 for the other town. This amounted to a difference in their annual revenuesharing allocations of about $55,000.

Attachment three to my complete statement shows, by State, the more extreme differences in per capita revenue-sharing allocations to similar local governments with equal fiscal efforts. Under the existing formula, for example, North Carolina cities have an extreme difference of $13.77 per capita.

Extreme differences can be misleading. I have therefore included attachment 4 which shows by State the average differences in revenuesharing allocations for equal fiscal effort governments. Under the existing formula similar local governments in 25 States have average differences of at least $3 per capita.

Modifications to the formula constraints would tend to reduce such inequities. However, most of the inequities will remain. While we have considerable analytical work remaining, it appears that tiering should be removed and the constraints modified to reduce the inequities in revenue-sharing fund allocations.

Changes produced by various modifications to the revenue-sharing formula is a very complex subject. We are performing extensive analyses of the formula including other combinations of formula constraints. We would be pleased to share these analyses and provide all the assistance we can to the subcommittee should you decide to pursue the issue.

Let me now turn to the work we are doing in examining the implementation of the audit requirements of the Revenue Sharing Act.

Although many governments have not yet submitted acceptable audits to the Office of Revenue Sharing, the revenue-sharing audit requirements and the Office of Revenue Sharing's quality control efforts have prompted substantial auditing improvements in the State-local

sector.

The Office of Revenue Sharing reviewed the audit work of all State audit agencies and 217 public accounting firms to determine if they were following generally accepted auditing standards. The Office cited 20 audit agencies in 17 States and 90 of the public accounting firms for material auditing deficiencies. Also, six State audit agencies were not considered independent.

The audit requirements and the Office of Revenue Sharing's quality control efforts have led to actual and planned corrective actions which are improving the quality of State and local governments' audits. State agencies and public accounting firms are placing more emphasis on internal control evaluations, audit planning, training, and personnel qualification requirements.

Although corrective action has already been taken or planned as a result of the revenue-sharing audit requirements, several State audit agencies have much to do before they can fully comply with the act. In many cases State agencies with auditing standards and independence problems will not be able to complete acceptable audits of their State and local governments in a timely manner.

Because these agencies are making a good faith effort to upgrade their auditing practices, we believe the Congress should amend the Revenue Sharing Act to provide explicit authority for the Secretary of the Treasury to grant waivers to governments audited by unacceptable State agencies. Such waivers should be contingent upon the State audit agencies submitting plans, timetables, and progress reports for taking appropriate corrective actions.

Notwithstanding the significant improvements in audits of State and local governments, there are uncertainties regarding the extent of ultimate compliance with the audit requirements. The first 3-year audit period expired on December 31, 1979, and the deadline for submitting audit reports for that period is September 1, 1980.

Recent Office of Revenue Sharing statistics show that less than half of the 11,000 governments required to be audited have submitted their audit reports. Many of those submitted are not acceptable due to auditors' failure to meet generally accepted auditing standards.

The Office of Revenue Sharing adopted an aggressive quality control program to enhance the quality of audits. Continuation of such an aggressive approach, including temporary suspension of revenuesharing payments, may be necessary to insure compliance with the audit requirements of the act. Office of Revenue Sharing officials have informed us that they intend to take such action when appropriate.

As you may know, we and the Office of Management and Budget have been advocating what we call the single audit concept. In essence, this means that instead of making individual audits of each grant a Federal grantee receives, the Federal Government would require one audit of the entire entity which would include all grants. This single audit requirement is found in OMB Circular A-102.

The audits of State and local governments, or their subunits, required by both the Revenue Sharing Act and this circular can be one and the same if properly planned. We favor changes in the act which would require that these two audit requirements be met by a single audit.

We are also interested in promoting improved accounting practices at the State and local levels of government and, it seems to me, that

the revenue-sharing program would be an appropriate vehicle for achieving this objective.

It is generally recognized that the accounting records of many State and local governments and the financial statements prepared from these records simply do not provide needed information and that actions are needed to improve the situation.

As you may know, there is a proposal being considered to create a board which would establish accounting standards for the State and local sector. The board would be much like the Financial Accounting Standards Board which establishes accounting standards for the private sector. The board would be called the State and Local Government Accounting Standards Board or some similar title.

If such standards were developed the revenue-sharing program could be used to promote adherence to the standards. The standard-setting effort will require some funding and we believe a reasonable amount of revenue-sharing funds should be earmarked to help support the effort. The money would be well spent because good standards could make Federal oversight of its grant and assistance programs much simpler and more effective.

Because of the subcommittee's interest, we also examined State and local government compliance with the citizen participation requirements.

Our review was made at 13 State governments and 168 local governments, 164 of which had populations of 10,000 or less. We concentrated on smaller local governments because two studies by other groups covered citizen participation at governmental units serving larger populations.

States and most small local governments were holding the public hearings required by the Revenue Sharing Act. However, few citizens attended the hearings, raising doubts about their effectiveness in fostering citizen participation in budgetary decisions.

All governments held the required second hearing which covers the proposed uses of revenue-sharing funds in relation to the governmental unit's entire budget. However, about 30 percent of the small communities reviewed did not hold the first hearing which covers only the proposed uses of revenue-sharing funds. The primary reasons cited by local officials for not holding the first hearing was that it would serve no useful purpose because no one shows up for the regular public meetings.

Although the requirements for publicizing the hearings were complied with, the hearings were poorly attended. About 50 percent of the local governments had no citizens attending the first hearing and 60 percent had no citizens attending the second hearing. Attendance at the hearings held by the remaining local governments, for the most part, was minimal.

We have reported previously that, due to the interchangeability of money, revenue from various sources loses its identity in the budget and expenditure process and that designating uses of revenue-sharing funds tends to be somewhat meaningless.

Therefore, the first hearing, covering only proposed uses of revenuesharing funds, appears to be of questionable value, particularly since the second hearing covers proposed uses of revenue-sharing funds in