The federal government funds programs that promote the economic viability of communities, encourage rural development, and assist in the nation's disaster preparedness and response. Function 450 includes funding for flood insurance and disaster relief, homeland security grants to pay state and local governments' first responders, the Community Development Block Grant program, credit assistance to rural communities, and programs that assist Native Americans.

Federal spending for community and regional development projects has risen substantially since the terrorist attacks of September 11, 2001, as lawmakers increased funding for recovery efforts and for grants to state and local first responders. About $60 billion was appropriated in this function for relief and reconstruction in the aftermath of the Gulf Coast hurricanes of 2005. In 2006, more than $20 billion in borrowing authority was provided to the National Flood Insurance Program to pay resulting claims. Because spending for hurricane relief is declining, outlays for function 450 are expected to total about $28 billion in 2007. Although that is about half the total for 2006, it still represents an increase of more than 100 percent since 2002.

The Community Development Block Grant (CDBG) program provides annual grants to communities to help them aid low- and moderate-income households, eliminate slums and blight, or meet emergency needs by rehabilitating housing, improving infrastructure, and carrying out economic development activities. Part of the program—referred to as the entitlement component—makes grants directly to cities and urban counties. (The program also allocates funds to states, which distribute them to smaller and more-rural communities—called nonentitlement areas—typically through a competitive process.) Funds from the entitlement component may also be used to repay bonds that are issued by local governments and guaranteed by the federal government under the Section 108 loan guarantee program. For 2006, the CDBG program received an appropriation of $3.7 billion, including $2.6 billion for entitlement communities.

Under current law, the CDBG entitlement program is open to all urban counties, principal cities of metropolitan areas, and cities with a population of at least 50,000. The program allocates funding according to a formula based on the community's population, the number of residents with income below the poverty line, the number of housing units with more than one person per room, the number of housing units built before 1940, and the extent to which population growth since 1960 is less than the average for all metropolitan cities. The formula does not require that a certain percentage of residents have income below the poverty line, nor does it exclude communities with high average income. A 2003 analysis from the Department of Housing and Urban Development, which administers the CDBG program, showed that funding under the formula shifted from poorer to wealthier communities, as measured by average poverty rates, when population data and other information were updated using results from the 2000 census.

This option would focus CDBG entitlement grants on needier areas and reduce funding accordingly. The option could be implemented in a variety of ways, but one simple approach would be to exclude communities whose per capita income exceeded the national average by more than a certain percentage. For example, restricting the grants to communities whose per capita income was less than 110 percent of the national average would reduce entitlement funds by 21 percent. To illustrate the general approach, this option would make a slightly smaller cut of 20 percent, which would save $1.7 billion over five years. (The Administration offered a proposal in 2006 to improve the formula's targeting of needy communities through a different set of changes. The proposal also included eliminating entitlement grants to communities whose formula allocation is relatively small—specifically, less than 0.014 percent of the total for all communities.)

One argument for narrowing eligibility for entitlement grants is that doing so would reduce the size of a program that should not exist at all because using federal funds for local development is never appropriate. An alternative argument is that even if the CDBG program can be justified because of its redistributive effects, redirecting money to wealthier communities serves no pressing interest.

The main argument against this option is that dropping wealthier communities from the CDBG program could reduce efforts to aid low-income households within those communities, unless local governments reallocated their own funds to offset the lost grants.

The Neighborhood Reinvestment Corporation (NRC) is a public, nonprofit organization charged with revitalizing distressed neighborhoods. The NRC oversees a network of locally initiated and operated groups called NeighborWorks Organizations (NWOs), which engage in a variety of housing, neighborhood-revitalization, and community-building activities. The corporation provides technical and financial aid to new NWOs and monitors and assists those already established. The NeighborWorks network includes over 230 member organizations operating in more than 4,400 communities nationwide. Congressional appropriations account for roughly 90 percent of the corporation's operating funds; for 2006, the NRC's appropriation was $117 million.

Under this option, the Neighborhood Reinvestment Corporation would be eliminated, saving $119 million in 2008 and $618 million over five years.

The NRC uses its funds to provide grants, conduct training programs and educational forums, and produce publications in support of NeighborWorks Organizations. The bulk of its grant money goes to NWOs, which use it to purchase, construct, and rehabilitate properties; capitalize revolving-loan funds; develop new programs; and cover operating costs. NWOs' revolving-loan funds make mortgage and home improvement loans to individuals as well as loans to owners of mixed-use properties who provide long-term rental housing for low- and moderate-income people. In addition, the NRC awards grants to Neighborhood Housing Services of America, which provides a secondary market for the loans made by NWOs.

One rationale for eliminating the NRC is that the federal government should not fund programs whose benefits are not national in scope. In addition, the NeighborWorks approach duplicates the efforts of other federal programs—particularly those of the Department of Housing and Urban Development (HUD)—that also rehabilitate low-income housing and promote home ownership and community development. Moreover, the NRC is a relatively minor source of funding for NeighborWorks organizations. In 2003, its grants accounted for less than 20 percent of NWOs' funding from government sources and less than 5 percent of their total funding. Larger shares came from private lenders, foundations, corporations, and HUD.

An argument against this option is that the large number of federal programs that exist to assist local development is evidence of widespread support for a federal role, particularly in areas where state and local governments lack adequate resources of their own. Furthermore, NWOs address problems in whole neighborhoods rather than individual properties. And, with their nonhousing activities (such as community-organization building, neighborhood cleanup and beautification, and leadership development), they provide economic and social benefits that other federal programs do not. Finally, the NRC may be particularly valuable because it has flexibility in making grants—which allows it to fund worthwhile efforts that do not fit within the narrow criteria of larger federal grantors—and because it provides the NWOs with needed training, program evaluation, and technical assistance.

The Community Development Financial Institutions (CDFI) Fund was created in 1994 to expand the availability of credit, investment capital, and financial services in distressed communities. Administered by the Treasury Department, the fund provides equity investments, grants, loans, and technical assistance to CDFIs, which include community development banks, credit unions, loan funds, venture capital funds, and microenterprise funds. In turn, those institutions provide a range of financial services—such as mortgage financing for first-time home buyers, loans and investments for new or expanding small businesses, and credit counseling—in markets that are underserved by traditional institutions. The CDFI Fund also provides incentive grants to traditional banks and thrift institutions to invest in CDFIs and to increase loans and services to distressed communities. In addition, the fund administers the New Markets Tax Credit (NMTC) program begun in 2002 to provide federal tax credits for qualified investments in "community development entities." The CDFI Fund received appropriations of $54 million in 2006.

This option would eliminate the CDFI Fund, reducing discretionary outlays by a total of $165 million through 2012. That estimate of savings takes into account the small amount of additional spending that would be required by other agencies to oversee the fund's existing loan portfolio and administer the NMTC program.

One rationale for eliminating the CDFI Fund is that local development should be financed at the state or local level, not by the federal government, because its benefits are not national in scope. Another argument is that the fund is redundant. Many other federal agencies and programs—including the housing loan programs of the Rural Housing Service, the Community Development Block Grant program, the Neighborhood Reinvestment Corporation, and the Economic Development Administration—support home ownership and local economic development. Those agencies and programs received appropriations of $21.5 billion in 2006, including supplemental appropriations of $16.7 billion to assist with recovery efforts related to Hurricane Katrina. Furthermore, assistance to CDFIs may be inefficient because it encourages loans that would otherwise not pass market tests for creditworthiness.

The primary argument against eliminating the CDFI Fund is that the federal government has a legitimate role in assisting needy communities, some of which lack access to traditional sources of credit. By helping existing CDFIs and stimulating the creation of others, the fund may provide an effective mechanism for leveraging private-sector investment with a relatively small federal contribution.

The Department of Agriculture's Rural Community Advancement Program (RCAP) helps rural communities by providing loans, loan guarantees, and grants for water, waste-disposal, and waste-management projects; community facilities; and various activities designed to promote economic development. The program received discretionary appropriations of roughly $718 million in 2006 for grants and for the budgetary cost of its loans and loan guarantees. (That cost is defined under credit reform as the present value of interest rate subsidies and expected defaults on the loans and guarantees.)

RCAP funds are generally allocated among states on the basis of their rural populations and the number of rural families with income below the poverty level. Within each state's allocation, the Department of Agriculture awards funds on a competitive basis to eligible applicants, including state and local agencies, nonprofit organizations, and (in the case of loan guarantees for business and industry) for-profit companies. The terms of a recipient's assistance depend on the purpose of the aid and, in some instances, on economic conditions in the recipient's area. For example, aid for water and waste-disposal projects can take the form of loans with interest rates ranging from 4.5 percent to market rates depending on the area's median household income. Areas that are particularly needy may receive grants or a mix of grants and loans.

This option would reduce future federal spending by providing money to capitalize state revolving funds for rural development and then ending federal assistance under RCAP. The amount of federal savings would depend on the level and timing of the contribution that capitalized the revolving funds. Under one illustrative approach, the federal government would provide funding of $718 million annually for five years to capitalize the funds and then cut off assistance in 2013. That approach would yield modest savings ($41 million) over five years but more-significant savings ($2.2 billion) through 2017. However, that level of capitalization would not by itself support the volume of loans and grants that RCAP now provides. Accordingly, the Congress could allow the revolving funds to use their capital as collateral to leverage additional financing from the private sector, as the state revolving funds established under the Clean Water Act and the Safe Drinking Water Act have been allowed to do.

The rationale for cutting off RCAP funding is that the federal government should not bear continuing responsibility for local development; rather, programs that benefit localities, whether urban or rural, should be funded at the state or local level. The rationale for the specific approach taken in this option is that a few years of federal funding to capitalize the revolving funds will provide a reasonable transition to the new policy.

One argument against converting RCAP to revolving funds is that states might change their types of aid (substituting loans for grants and high-interest loans for low-interest loans) to avoid depleting the funds and to recoup the costs of any leveraged financing. Such a change could price the aid out of reach of needier communities. In addition, the estimated federal savings might not materialize: for example, the Congress has appropriated additional grants to state funds for wastewater treatment systems after expiration of the original authorization for those grants. Moreover, the component of RCAP that receives the majority of the funds, the program for water loans and grants, has been judged to be "effective" by the Office of Management and Budget.

The federal government provides annual funding to three regional development agencies: the Appalachian Regional Commission (ARC), the Denali Commission, and the Delta Regional Authority. The ARC, established in 1965, conducts activities that promote economic growth in the Appalachian counties of 13 states, stretching from southern New York to northern Mississippi. Modeled after the ARC, the Denali Commission, which was created in 1998, covers remote areas in Alaska. Similarly, the Delta Regional Authority, established in 2000, covers 240 counties and parishes near the Mississippi River in eight states, stretching from southern Illinois to the Louisiana coast. For 2007, the Congress appropriated $65 million for the ARC, $51 million for the Denali Commission, and $12 million for the Delta Regional Authority.

This option would discontinue federal funding for the Appalachian, Denali, and Delta regional development agencies. That change would reduce discretionary outlays by $11 million in 2008 and by $169 million over five years.

The three agencies provide programs that are intended, among other things, to create jobs, improve rural education and health care, develop utilities and other infrastructure, and provide job training. However, it is difficult to assess whether such outcomes can be attributed to those programs, to other governmental and nongovernmental organizations, or to the effects of general economic conditions.

An argument for ending federal funding of the three agencies is that such action would shift more responsibility for supporting local or regional development to the states and localities whose citizens would benefit from that development. Another rationale for the option is that needy areas exist throughout the country; therefore, Appalachia, rural Alaska, and the Mississippi Delta should have no special claim to federal dollars. In that view, any federal development aid they do receive should come from nationwide programs, such as those overseen by the Economic Development Administration, rather than from federal programs that focus on specific regions.

The main arguments against this option are that the federal government has a legitimate role to play in redistributing funds among states to support development in the neediest areas and that cutting federal funding would reduce local progress in education, health care, and job creation. Another argument is that Appalachia, rural Alaska, and the Mississippi Delta merit special attention because of the extent of poverty that exists in those regions. An additional argument against eliminating the Delta Regional Authority is that there is an added need for established organizations to help with the redevelopment effort in the Mississippi Delta following the devastation caused by Hurricanes Katrina and Rita.

The Department of Homeland Security (DHS) issues grants to local governments to help police, firefighters, and other first responders prepare for terrorist attacks—by, for example, receiving biohazard training, acquiring special equipment (such as chemical suits), and providing additional physical security for critical infrastructure. For 2007, the Congress appropriated about $2.5 billion for homeland security grants, which are administered by DHS's Preparedness Directorate. Of the amounts appropriated for 2007, $875 million will be distributed through the State Homeland Security Grant Program and the Law Enforcement Terrorism Prevention Program using a formula that guarantees that no state will receive less than 0.75 percent of the appropriation. That approach may not fully reflect certain communities' potential attractiveness as terrorist targets or the scale of prospective human and economic loss from an attack.

This option would have three components: eliminating the practice of allocating first-responder grants by formula, cutting 25 percent of the funds that are now distributed that way, and directing DHS to allocate the remaining 75 percent using criteria that reflect risk and the effectiveness of the proposed uses of the grants. DHS already uses such criteria to allocate discretionary first-responder grants, such as those in the Urban Areas Security Initiative. The option would save $68 million in 2008 and $885 million over five years.

Proponents of eliminating formula-based funding argue that many grants now go to communities with small and dispersed populations, little critical economic activity, or few evident targets for terrorists. Those communities may be less likely to be attacked and, if they were, would incur relatively small losses. Supporters of altering the formula also point out that not all the money currently available has been spent: as of September 31, 2006, more than $5 billion in prior-year funding had not yet been disbursed. And, according to some observers, the dollars that were spent yielded little increase in national security, either because much of the spending did not enhance emergency preparedness or because it simply replaced other sources of funding for ongoing preparedness efforts.

Opponents of changing the current allocation note that DHS already provides funds for other security programs (such as those at airports, seaports, and other transportation centers) that selectively benefit communities where risks of attack and losses may be greater. In addition,federal regulatory programs and private businesses are working to help protect prime targets in those at-risk communities. Thus, opponents of this option argue, continuing to issue first-responder grants on the basis of geography may help restore balance in the allocation of funding. Moreover, terrorism is only one of many risks that communities face. Preparations nominally intended to deal with terrorist attacks may help mitigate the costs of crime, fires, storms, floods, or earthquakes—threats that exist everywhere. Advocates of that view support legislation that would broaden the uses for DHS's first-responder grants to include preparations for all types of disasters.

The Small Business Administration (SBA) provides low-interest loans to households, businesses, and nonprofit organizations that have suffered losses in events declared disasters by the President. With some exceptions, the loans can be used to replace personal property or business machinery, equipment, and inventory; to repair or restore damaged homes or business structures; to provide operating funds while a business recovers; and for certain other purposes. SBA sets the duration of each loan on a case-by-case basis, according to the borrower's ability to repay. The interest rate on loans to recipients who can obtain credit elsewhere is based on the federal government's borrowing cost (but is capped at 8 percent); other recipients pay interest at half that rate.

This option, consistent with a proposal included in the President's budget for 2007, would limit the interest subsidy on all new disaster loans offered by the SBA to the first five years after origination, with the rate increasing thereafter to reflect the rate the Treasury pays to borrow money for a similar length of time. The option would save $12 million in 2008 and $109 million over five years. (Budgetary savings would occur immediately because, under the Federal Credit Reform Act, the budgetary cost of a loan is incurred at origination and is calculated as the present value of the loan's expected subsidy cost and default risk.)

The argument for imposing such a time limit on the subsidy on disaster loans is that five years is adequate time for disaster victims' finances to stabilize, so by that point, the recipients have no special claim on federal aid. The argument against the time limit is that, in many cases, borrowers' losses still represent significant reductions in their wealth after five years, even if their current finances have stabilized. The fact that SBA sets a repayment period longer than five years for a given loan indicates that the repayment is expected to continue to pose a financial burden.

The National Flood Insurance Program (NFIP) charges two different sets of premiums to insure buildings and their contents. One set applies to structures built either before 1975 or before the completion of a community's official flood insurance rate map (FIRM). Those structures are classified as "pre-FIRM." The other set of premiums applies to "post-FIRM" structures. Post-FIRM premiums are intended to be actuarially sound (that is, to cover the costs of all insured losses over the long term). They are based on a building's elevation relative to the flood level that is thought to have a 1 percent chance of being equaled or exceeded each year in that location. Pre-FIRM rates, by contrast, are heavily subsidized, on average, and do not take into account a building's elevation.

The Federal Emergency Management Agency (FEMA), which administers the flood insurance program, estimates that 26 percent of such policies are priced at subsidized rates. The subsidies are available only for the first $35,000 of coverage on a one- to four-family dwelling and for the first $100,000 of coverage on a larger multifamily residential, nonresidential, or small-business building. Various levels of additional coverage are available at actuarially sound rates. Taking both the subsidized and unsubsidized tiers into account, FEMA estimates that the average subsidies for both buildings and contents amount to roughly 60 percent—that is, premiums represent 40 percent of the actuarial value of the insurance. (The subsidy for a particular building can vary greatly from the average, however, depending on the building's elevation.)

One way to reduce the cost of the subsidy would be to phase it out over five years. That change would increase the program's premium income by about $2 billion over the 2008-2012 period. Those estimates take into account the likelihood that some current policyholders would drop their coverage in the absence of the current subsidy. (Carrying flood insurance is voluntary in some cases; and even where it is required, compliance is far from complete.) Alternatively, smaller reductions in program costs could be realized by phasing out the subsidy on all insured pre-FIRM structures other than primary residences—in other words, on second and vacation homes, rental properties, and nonresidential buildings—or by eliminating the subsidy on all new policies, including those purchased by new owners after properties are sold. However, none of the approaches would lead to any net budgetary savings, the Congressional Budget Office estimates. Currently, the program must use nearly half of its annual income from premiums to pay debt-service costs on the $17 billion it has borrowed (to date) to pay claims resulting from the Gulf Coast hurricanes of 2005. The remaining half is not enough to cover the average annual cost of future claims. Thus, under current law, the effect of the additional receipts generated by the option would be to allow the NFIP to pay claims that it otherwise would lack the resources to pay, and the benefit would go not to the federal Treasury but to flood-insurance policyholders.

Proponents of eliminating the subsidy on at least some pre-FIRM structures argue that the subsidy has outlived its original justification: to serve as a temporary incentive to encourage participation among property owners who were not previously aware of the magnitude of the flood risks they faced. According to that view, charging actuarial rates on pre-FIRM properties would make those policyholders pay their fair share for insurance protection; it would also give them appropriate incentives to relocate or take preventive measures.

One general argument for maintaining the subsidy is that charging full actuarial rates for properties built before FEMA documented the extent of local flood hazards is unfair. A second such argument is that actuarial rates would be very high in some cases—as much as ten times the current subsidized rates—posing financial hardships to some property owners and reducing property values in some communities. Also, actuarial premiums that reduced participation in the program could lead to greater spending on federal disaster grants and loans, thus eroding some of the projected savings.

Other arguments—both for and against eliminating the subsidy—focus on particular sets of properties. An advantage of phasing out the subsidies on all pre-FIRM properties is that doing so ultimately would make the program actuarially sound, thereby helping the most to reduce the need for future loans from the general Treasury like those required in the aftermath of Hurricanes Katrina and Rita in 2005. (Because of the built-in subsidies, the NFIP never accumulated reserves for such catastrophic events and is unlikely ever to be able to repay those loans.)

By contrast, keeping the subsidies for primary residences could be justified as improving the program's financial position to some degree while focusing the remaining subsidies on structures whose owners might face the greatest hardship in paying actuarial rates. Opponents of that approach note, however, that ending subsidies for rental properties might cause owners to pass on increased costs to renters.

Finally, an argument for limiting the subsidy-elimination effort to new policies is that purchasers are now well aware of the dangers posed by floods, whether their properties are pre-FIRM or post-FIRM. Again, however, some of the general arguments against eliminating any pre-FIRM subsidies can be made: Large increases in flood insurance premiums could lead to financial hardship for some property owners, reduced property values for some communities, and increased federal costs for disaster assistance.

Almost all policies sold in the National Flood Insurance Program (NFIP) are issued and administered by private insurance companies that participate in the NFIP's Write Your Own (WYO) program. Begun in 1983, the program is designed to increase the number of NFIP policies sold, improve service to policyholders, and provide the insurance industry with direct experience handling flood insurance. The WYO companies act as agents for the NFIP, which determines premium rates and underwriting rules and bears sole responsibility for paying claims. Participating companies are allowed to retain a share of the premiums they collect as an expense allowance; that share—currently 30.2 percent—is determined annually by the Federal Emergency Management Agency (FEMA) on the basis of industry expense data for similar lines of insurance (such as fire and homeowners multiple peril) as reported by A.M. Best. Also, when policyholders incur losses that are covered, the companies receive additional compensation equal to 3.3 percent of the value of the claims they handle. As of November 2006, FEMA's Web site listed 86 companies participating in the program.

This option would direct FEMA to reduce the WYO expense allowance by 1 percentage point while leaving policyholder premiums unchanged. Such action would increase receipts by $26 million in 2008 and by $137 million over five years. (Option 350-4 discusses a similar change to the Department of Agriculture's crop insurance program.) However, the increase in receipts would not lead to any net budgetary savings, the Congressional Budget Office estimates. Currently, the program must use nearly half of its annual premium income to pay debt service on the $17 billion it has borrowed (to date) to pay claims resulting from the Gulf Coast hurricanes of 2005, and the remaining half is not enough to cover the average annual cost of future claims. Thus, under current law, the effect of the additional receipts generated by the option would be to allow the NFIP to pay claims that it otherwise would lack the resources to pay, and the benefit would go not to the federal Treasury but to flood insurance policyholders.

The main argument in favor of reducing the expense allowance is that the A.M. Best data used by FEMA to calculate the expense allowance may yield overestimates of the costs that the companies incur as a result of selling NFIP policies. The traditional insurance industry practice of compensating agents in proportion to the dollar value of the policies they sell seems to reflect costs in an approximate, average way at best. For example, differences in elevation (relative to the water level expected in a "100-year flood") can make the insurance premium on one property much higher than that on a second property that otherwise is identical, but such differences do not affect the amount of time involved in selling the coverage. Moreover, even within the traditional percentage-of-premium approach, the A.M. Best data may overstate WYO costs: Because most flood insurance is sold in conjunction with other policies (such as homeowners insurance), advertising and other marketing costs are minimal. The fact that participation in the Write Your Own program is so widespread suggests that FEMA may have room to reduce the expense rate. Also, reducing the expense allowance while leaving the premiums unchanged would slightly reduce the structural deficit built into the NFIP by the subsidized rates charged on older buildings (see Option 450-8).

The main argument against the option is that it could lead to the sale of fewer NFIP policies: If insurers did not receive adequate compensation for their costs, they might drop out of the program; and some potential purchasers who were no longer able to buy flood insurance from the same agent who sold them other coverage might not make the additional effort to find a second source. The option could also lead to an increase in FEMA's own administrative expenses if the number of policies sold by the agency itself increased. Alternatively, if the participating companies truly have been overpaid, then policyholders insured at full-rate premiums have been paying too much for their coverage, and the benefit of reducing the expense allowance on their policies should be passed on to them in the form of reduced premiums, not retained by the NFIP. To the extent that the NFIP's structural deficit is a problem, it could be addressed more directly by reducing or eliminating the subsidies rather than through hidden cross-subsidies from policyholders who pay full-rate premiums.