CDFA Spotlight: Tax Increment Bonds By Stan Provus

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This article explains tax increment bonds, sometimes called tax allocation bonds.

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This article is intended to provide accurate and authoritative information in regard to the subject matter covered. The author and CDFA are not herein engaged in rendering legal, accounting or other professional services, nor does it intend that the material included herein be relied upon to the exclusion of outside counsel.

Tax increment financing funds infrastructure improvements through a partnership between local government and a private developer or company. Expected growth in property tax revenues from a designated area are used to finance the bonds that pay for improvements in the TIF district. Some states also allow local sales tax and earnings tax revenues to fund the increment as well as property taxes.

Tax increment financing bonds are issued both as (1) pure revenue bonds, secured solely by incremental tax revenues or (2) as a type of double borrowed general obligation bond. With the general obligation bond approach the bonds are credit enhanced by the full faith and credit of the issuer or plan sponsor. In the absence of this credit enhancement, the bond market would be likely to exact an interest rate premium or discount the revenue stream and reduce the amount of borrowing, or a combination of both. If the sponsor pledges its full faith and credit, the sponsor (and not the marketplace) will bear the risk that the projected incremental revenue will not materialize—meaning, if the incremental tax revenues are not sufficient to pay debt service on the bonds, the entity that pledges its faith and credit must pay.

The primary credit risk of tax increment financing for the tax increment district is that tax rates and the pace of private development in a project area lie outside the control of the redevelopment agency issuing the debt. Actual tax rates that generate the tax are set by the underlying taxing entities-- cities, counties, or school districts, among others—that set their tax rates without consideration of the needs of the redevelopment agency.

Under tax increment financing, developers or companies continue to pay real estate taxes on the value of the property prior to the creation of the TIF district. As the improvements increase the value of their property, however, the new tax money is directed into a fund to pay debt service on bonds or for the improvements.

The TIF system relies on the appreciation in value of the land and buildings in a TIF district. If a development is profitable, then the costs will be paid for in the growth of property tax revenues. If the property fails to increase in value, the improvement costs fall back on the general taxpayer (assuming the bonds are issued as general obligation bonds and not pure revenue bonds). Forty-nine states use TIF bonds.

This article is intended to provide accurate and authoritative information in regard to the subject matter covered. The author and CDFA are not herein engaged in rendering legal, accounting or other professional services, nor does it intend that the material included herein be relied upon to the exclusion of outside counsel. CDFA is not responsible for the accuracy of the information provided in this fact sheet. The information provided has been collected from a variety of sources. Those seeking to conduct complex financial deals using the tools mentioned in this document are encouraged to seek the advice of a skilled legal/consulting professional.