|
| |
|
Learning from Experience: A Primer on Tax
Increment Financing | ||
 |
IBO Fiscal Brief September 2002 New York City Independent Budget Office Learning from Experience: A Primer on Tax Increment Financing SUMMARY To fund the estimated $1.5 billion extension of the No. 7 subway and perhaps other redevelopment proposals on Manhattan's Far West Side, there has been increasing discussion of using a borrowing method known as tax increment financing, or TIF. The basic idea underlying TIF is that a city or town finances an improvement in a specific district with the property tax revenue generated by that improvement. While TIF has been used extensively throughout the country in cities such as Chicago, Los Angeles, and Washington, D.C., it has never been used here. This report provides a primer on TIFwhat it is, key features of the laws that authorize it, the types of projects undertaken, some of the reasons for its popularity, and a review of how it has worked in some other localities. Among the lessons from our review:
The report concludes with a discussion of issues that will have to be considered before relying on TIF for financing the proposed subway extension. These considerations will be more closely examined in a subsequent IBO report that will look at the viability of tax increment financing for extending the No. 7. INTRODUCTION Extension of the No. 7 subway line west and south from Times Square is seen as critical to the success of several of the major proposals for development of Manhattan's Far West Side as an extension of midtown.[1] These include proposals from the Department of City Planning, the NYC2012 Olympic Committee, and the Group of 35, chaired by Senator Charles E. Schumer and former Treasury Secretary Robert E. Rubin. To pay for the estimated $1.5 billion subway extension-and possibly other capital improvements in their plans-each of these groups propose using tax increment financing (TIF), a method of financing projects never used before in New York City.[2] This report provides a primer on TIFwhat it is, key features of the laws that authorize it, how it has been used in other places, and some of the reasons for its popularity. HOW TIF WORKS In theory, tax increment financing works as follows:
In some states, private developers can also arrange their own financing, and the municipality uses the tax increment to reimburse the developers as the tax revenues are received. In the case of the Far West Side, the various plans indicate that the TIF district could include much of the area between 28th and 42nd Streets between 9th and 12th Avenues. The key improvement to be financed would be the extension of the No. 7 line west from Times Square.[3] STATE AUTHORIZATION Although TIF differs from traditional methods of financing public investments, it is still a form of public debt and as such must be authorized by state legislation. The first state law to authorize tax increment financing was passed by California in 1952, although most states were slow to follow.[4] By 1970, just six more states had enacted laws authorizing TIFMinnesota, Nevada, Ohio, Oregon, Washington, and Wyoming. By 1997, however, 48 states had enacted TIF laws, and the District of Columbia joined the list in 1998. New York's TIF law (General Municipal Law Section 970-a et.seq.) was passed in 1984. As of today, North Carolina and Delaware are the only states that have not authorized the use of tax increment financingalthough the Delaware House of Representatives recently passed TIF legislation. The widespread adoption of TIF laws since 1970 reflects a combination of several factors. While the continued decline of urban areas-particularly of central cities-created a growing need for redevelopment in the 1970s and 1980s, federal assistance for urban renewal projects fell, and voter opposition to new taxes rose. Tax increment financing represented a politically viable tool for local government officials to publicly finance infrastructure and other economic development initiatives without drawing on existing revenues or proposing new taxes. Characteristics of TIF laws. Like TIF laws in most states, New York's law provides TIF as a tool to eliminate "blight," subject to the constraint that a municipality can only engage in redevelopment which "cannot be accomplished by private enterprise alone" (General Municipal Law Section 970-b Legislative findings and declaration). The law stops short of saying how this private enterprise condition should be satisfied, however, and gives the municipality significant discretion in defining blight.[5] Relatively few state laws provide quantitative criteria to be applied in identifying blight. Some state laws explicitly allow the use of TIF for economic development without a finding of blight. Under New York State's law, a municipality has the power to issue TIF bonds.[6] In contrast to general obligation bonds, TIF bonds are not secured by the "faith and credit" of either the city or the state, and the TIF debt does not count against the municipality's constitutional debt limit. Like general obligation debt, however, interest on TIF debt may be tax exempt if it satisfies certain criteria set out in the federal Tax Reform Act of 1986. Although some states allow municipalities to use sales or personal property tax revenue to finance TIF debt, the law in New York and most other states allow only real property taxes to be used. Specifically, the New York law requires that property taxes for the TIF district be divided as follows: the municipality receives an amount equal to the current property tax rate applied to the last assessed property value for the TIF district before the TIF district was formed; once the municipality has been paid, the remaining revenue can be used to pay the service on the TIF debt; if there is any excess revenue, it must be returned to the municipality. New York State's current TIF law has no provision for sharing the tax increment with other taxing entities although in the case of New York City, which is a single tax entity that provides all services typically provided by a municipality, school district, and county combined, such a provision would be irrelevant if it did exist. In some states in which entities other than the municipality have claims on local property taxes (school districts and counties, in particular), state laws require that these other entities get a share of the tax increment. For example, California requires that a TIF district allocate a fixed percentage of the tax increment to the other tax entities, and the required percentage rises with the age of a project. Such provisions allow the other tax entities to benefit from growth within the TIF district. Other rules for TIF projects are relatively flexible under New York State's law. Industrial, commercial, and residential development can all be included in a redevelopment plan for a TIF district.[7] Unlike some states, which impose size (acreage) or time limits on specific TIF projects, New York imposes neither. TYPICAL TIF-FUNDED PROJECTS TIF has been used to finance a wide array of projects, including public infrastructure, private development, and brownfield cleanup. Public works projects are typically small-scale. Examples include land acquisition, installation of streetlights and water and sewer lines, roadway expansions, and construction of public parking garages. Large-scale projects have usually been joint ventures, most often with private partners. In joint ventures, the TIF financing is used only to finance the public contribution to the project. Examples of relatively large TIF-funded projects include the following:[8]
THE DRAW AND DRAWBACKS OF TIF For local policymakers, TIF has many attractive features. But it also has potential drawbacks that need consideration. The TIF draw. There are several features that draw policymakers to using TIF financing. As noted previously, TIF debt typically does not count against a municipality's debt limit, nor is the municipality or state responsible for repayment from sources other than the tax increment for the TIF district. Perhaps equally as important, the local government essentially has full control once the state TIF law is in place. Plans are generally not subject to state approval.[9] Another factor explaining TIF's popularity is voter opposition to tax increases. Because property tax revenue from pre-TIF assessments flow from the TIF district to the municipality as before, it is possible to portray any additional property taxes paid by property owners in the TIF district as payment for benefits received from TIF improvements. Potential drawbacks. While TIF has proven to be an effective and flexible financing method in a variety of settings, some municipalities have encountered problems with their TIF projects. Sufficient revenue. Actual TIF revenues may fall short of the projections made when the TIF bonds were sold. Unlike a municipality with a variety of revenue sources to draw upon for debt service obligations, a TIF district generally has only one source: incremental property taxes. A shortfall risks default or a bailout using other municipal revenues, undermining the reason for using TIF in the first place. A revenue shortfall can occur for a variety of reasons. The projected level of development might not be reachedor might be reached with significant delay. Assessed property values for a TIF district might also decline, at least temporarily. The city of St. Petersburg, Florida ran into difficulties in its TIF districts because of recession, public acquisition of private property, and acquisition of private property by tax-exempt entities within the district, removing them from the TIF tax base as well.[10] In their Bayboro Harbor TIF district (established in 1988), for example, the actual 1998 taxable property value for the district was $20.7 millionabout 60 percent less than the projection made at the start of project, and about 25 percent less than its pre-TIF value of $28.1 million. Tax increments may also drop or grow more slowly than expected due to policy decisions. California's Proposition 13 probably represents the most familiar example of an unexpected change in the property tax code.[11] More recently, when the state of Minnesota took over education finance last year, the education portion of local property tax increments that previously had gone to TIF projects was redirected to the state. TIF districts suddenly lost about 37 percent of the total increment they had received before the change in policy. Property tax abatements or exemptions, which are often used as incentives for developers, can also reduce tax revenues below projections if not anticipated correctly. A study of Michigan TIF districts found that taxable property values in some districts actually declined from their base values, despite positive growth in commercial property values. The reason was the concurrent granting of property tax abatements for properties in the districts.[12] Some project costs or changes in property values also are very difficult or impossible to anticipate. For example, the town of Greenburgh, New York accumulated legal bills and settlement costs when it was sued over the price it paid for a property in its TIF district. The city of East Grand Forks, Minnesota saw a drop in taxable property value in one of its TIF districts when a grain elevator burned down.[13] To reduce the risk of default, a municipality may designate a relatively large TIF district. Indianapolis did this when it used TIF to finance its downtown Circle Centre mall. Alternatively, a back-up revenue source can be built into the plan. St. Petersburg has used franchise taxes and parking revenue as its secondary revenue source, while East Grand Forks used lease payments and general revenue to fill its gap. Of course, both of these policies redirect resources from other uses and stand at odds with the conceptual underpinnings of TIF. The Redevelopment Agency of the City of San Jose, California uses a third strategy to reduce the risk of default-joint financing of TIF districts. Bonds are issued for all projects funded by the agency and tax increments from all TIF districts are used to service the debt. Their 2003-2007 Capital Improvement Plan includes 157 capital projects and programs in TIF districts all over the city with a total cost of $882 million.[14] Yet another strategy to reduce risk is a loan guarantee from a private developer. Hoffman Estates, a suburb of Chicago, required such a guarantee when it entered a TIF deal with Sears for relocation of its headquarters and development of a new office park in Hoffman Estates. When tax increments have fallen short of required payments, Sears has paid the difference.[15] In the event that tax increments do fall far short of projections, the initial debt might be refinanced or restructured. St. Petersburg has taken both measures in recent years, in addition to lining up secondary revenue sources. Cost spillovers. Another potential problem with TIF is spillover of costs to taxpayers outside the TIF district. Municipal service requirements such as police, fire, sanitation, education, and transportationwill almost certainly rise as development occurs within a TIF district. In turn, the regular property taxes paid to a municipality by property owners within the TIF district-which are based on pre-TIF assessments-could well fall short of the cost of services provided for the TIF district. When this happens, taxpayers outside the TIF district are faced with the tab. The larger the TIF district, the larger this impact will be on the surrounding area. One source of revenue to cover these additional costs could be the additional sales and income tax revenue generated by the new development in the TIF district. Whether these additional revenues are sufficient will depend on the intensity of the development induced by the TIF-financed improvements and whether other sales and income tax incentives are also available within the TIF district. Some critics of TIF have questioned whether the amount of tax revenue generated by TIF improvements actually equals the tax increment revenue allocated to pay for the improvements. Using data for a sample of 38 TIF districts in California and 38 matched areas with similar characteristics, the most comprehensive analysis of this question found only four TIF districts where property values outgrew their matches by enough to justify the tax increment received by the TIF districts.[16] A total of eight projects generated at least 80 percent of the revenue they received. Not surprising, the TIF districts with the most vacant land before the projects began showed the greatest tax increment growth. Overall, the study found that the 38 TIF districts collectively generated about half the tax revenue they received. This suggests that, on average, the TIF districts could have generated additional revenue equal to half the revenue generated with the TIF improvements even if the improvements had not been made, and that this revenue would have been available to pay for some portion of the additional services required by the TIF districts or other capital improvements. Benefit spillovers. In direct contrast to concerns about cost spillovers are concerns about benefit spillovers. If a TIF improvement has regional benefits, many who benefit significantly from the improvement may make no contribution to cover the cost. For example, the taxpayers of Indianapolis are financing a mall and two sports arenas with TIF, while benefits are enjoyed by all in central Indiana. Fragmentation of the tax base. Some observers say that the use of TIF may ultimately lead to fragmentation of the tax base, under which thriving neighborhoods would retain all growth in their property tax collections for their own development, rather than contributing part of this growth to citywide investments and assistance for less prosperous neighborhoods. Concern about fragmentation has been expressed in Chicago, which now has over 100 TIF districts within its boundaries. Distribution of development. Another potential problem is not specific to TIF but instead pertains to all geographically targeted economic development programs. It is possible that TIF projects may simply shift development around the city, rather than attracting new business to New York City from elsewhere in the region and beyond. This appears to be happening in Columbus, Ohio, where the city has sold more than $30 million in TIF bonds to finance infrastructure improvements for the new Arena District, a large office and retail development project that is centered on the new home of the Columbus Blue Jackets hockey team. Just a few miles downtown, office vacancy rates are above 20 percent and the City Center mall (which was built in the 1980s with city assistance) sits half empty.[17] Similar criticism has been voiced in Dallas about the proposed Victory office-retail complex between the city's new hockey arena and downtown.[18] Opponents argue that downtown Dallas retailers will be hurt, and they point to other city priorities, including more than $1 billion in needed roadway repairs elsewhere in the city. In a worst-case scenario, TIF could shift development from more to less productive locations. If this happens, tax revenueproperty, sales, income, and otherscould actually be reduced from its potential maximum. A study of municipalities surrounding Chicago found evidence consistent with this hypothesis.[19] Their results suggest that total assessed property values in cities that used TIF grew more slowly than in cities that did not, after controlling for area characteristics. Potentially expensive debt. Also of concern may be the relative cost of TIF debt. Because TIF debt is not backed by the "faith and credit" of the city or state, investors could view it as more risky than general obligation debt and demand a higher interest rate. To reduce the potential risk of default to investors, policymakers might designate a relatively large TIF district or build in a back-up revenue source, but these tactics have opportunity costs, as noted above. An additional issue that arises with large-scale TIF-financed projects is required payment of debt service before significant revenue gains are realized. For large projects in a city's general capital plan, funds may be drawn from alternative sources. But in the absence of such other funding sources, the first several years of debt service must also be borrowed, adding to the total project cost. CONSIDERING TIF FOR EXTENDING THE NO. 7 LINE Determining whether tax increment financing is the best financing methodor even a viable onefor the proposed extension of the No. 7 subway line goes beyond the objective of this report. But the information provided above points to some of the major issues that must be addressed when evaluating the subway TIF proposals. Property tax revenues for the TIF district must be projected cautiouslyallowing for potential fluctuations in the real estate market and local economy, construction delays (for the subway and other projects), and other factors that have created financial difficulties elsewhere. Economic development policies for the TIF district need to be coordinated with development policies for the rest of the city. How will development of the Far West Side impact development elsewhere in the city, and vice-versa? In particular, how will development of Lower Manhattan interact with development of the Far West Side of midtown if the two projects occur at roughly the same time? The city should also consider the cost of additional municipal services that the TIF district will require as the Far West Side develops. The final plan should estimate these costs and identify how they will be covered. The Department of City Planning has suggested the need for changes in New York's existing law, but has not yet indicated what changes would be required. As it stands, the law does not authorize the city to establish a public benefit corporation to oversee the TIF district, for example, and the city might want to take this approach for many reasons.[20] Limits on lessons learned. Lessons learned from other TIF users may take New York City only so far. Most important, the estimated $1.5 billion cost for the proposed subway extension dwarfs the project costs financed with TIF to date. TIF has been used in two locations in New York State, the town of Victor in Ontario County and the town of Greenburgh in Westchester County. In both cases, the commitment of the town was relatively small. Greenburgh used approximately $1.2 million to make road improvements (including the legal costs noted above). Victor provided approximately $8 million in financing for the renovation and expansion of a mall. Some projects outside New York State have been larger. But the most costly TIF project IBO identified was the construction of the United Airlines Maintenance Center in Indianapolis in the early 1990s. Although the total cost of the project exceeded $1 billion, the cost was shared by the city, state, and United Airlines. Indianapolis financed about $244 million with TIF. Measures that have allowed other cities to use TIF successfully may not work on a project as large as the subway expansion. A second limitation of existing evidence on TIF is its lack of information about how private development responds to major infrastructure projects, as would be required in the Far West Side proposals. The large TIF-financed infrastructure projects that IBO identified were generally parts of larger plans with private developers lined up in advance. Because the scale and timing of the private development response to the No. 7 subway extension would be pivotal to success of the proposed TIF financing, the development responses to other major infrastructure projectsincluding the New York City subwayshould be examined carefully as part of the evaluation of TIF. Written by Theresa J. Devine
END NOTES
New York City |
|
