But no free lunch! Read it and weep.
March 2007
At the Tipping Point
Has tax increment financing become too much of a good thing?
By James Krohe Jr.
To its advocates, tax increment financing is the greatest thing to happen to cities since paved streets. TIF allows municipalities, counties, or designated development agencies to borrow against future property tax revenue to pay for the public improvements needed to help generate those revenues. As the Denver-based Front Range Economic Strategy Center recently noted, "Tax increment financing subsidies are like a development credit card for the city: Buy a project now and pay it off with future revenue."
But as anyone who has a credit card knows, the temptation to misuse it can be strong.
Financing of last resort
For many years after tax increment financing was first introduced in the 1950s, it was used only as financing of the last resort —” money for slum or blighted urban areas that couldn't be raised any other way. So many projects struggled financially in the early years, however, that experts concluded TIF was an ineffective way to finance redevelopment of economically marginal sites. Relatively few states added TIF authorization to their statute books, and municipalities where this tool was allowed used it sparingly, if at all.
That changed in the 1980s, when many states passed new TIF-enabling laws or amended their old ones to allow its use on a wider variety of properties. They did this by redefining blight more broadly or by adding general economic development as one of the essential public purposes for which a TIF district could be established. Some states added categories of properties that qualified for TIF as a matter of course. Examples include industrial areas with a labor surplus or decommissioned military bases. By the 1990s, amendments to TIF-authorizing laws allowed its use for construction of low- and moderate-income housing or for workforce development.
Today 49 states and the District of Columbia allow some form of TIF. (Arizona once did, too, but no longer does.) Today, TIF districts have become the first tool that local governments pull out of their economic development toolbox —” even in suburbs and rural counties. (Tax increment financing is crucial in funding Iowa's rural improvement zones, for example.) Thousands of TIF-designated districts have been set up nationwide.
Now it's hard to find many major building projects —” shopping centers, hotels, office buildings, and mixed use residential complexes —” that are not financed in part by TIF. California has used it to support virtually all its military base conversion projects. Other TIF-financed projects include the downtown operations centers for Mellon and PNC banks in Pittsburgh, the RiverPlace waterfront complex in downtown Portland, Oregon, Atlantic Station's city-within-a-city in Midtown Atlanta, and construction or rehab of several theaters that make up Chicago's revived Loop theater district.
The proverbial free lunch?
Backers say that TIF subsidies are basically self-financing, and thus the closest thing there is to a free lunch. Using these subsidies, municipalities rid themselves of blight without raising taxes, developers shift some or all of their construction costs onto a municipality, and citizens enjoy the fruits of a stronger local economy and a more attractive community.
Tax increment financing, says Rachel Weber, an assistant professor in the Urban Planning and Policy Program at the University of Illinois at Chicago, "provides planners and local governments with lots of flexibility and money to implement projects."
The reality isn't that simple. As TIF's popularity as an instrument of local government finance grows, so do controversies about its use among local government officials, academics, and community activists. Some argue that TIF works reliably only in areas where it isn't needed, or that it subsidizes sprawl.
Others point out that it shortchanges other government agencies because tax revenue is diverted over the course of years to pay off the TIF debt —” in short, that tax increment financing is less a mechanism for value creation than value theft. In the opinion of Mike Quigley, a county commissioner and long-time critic of Chicago's aggressive use of TIF, in many cases TIF districts act like a reverse Robin Hood: "They rob from the average taxpayer to give to multimillion-dollar development projects in thriving areas of the city."
Even TIF advocates (mainly municipal officials and private finance and development professionals) concede that TIF has been overused in the past decade. In every state in which this tool is widely used, there are efforts to reform the practice both in city councils and state legislatures, mainly by building more rigorous standards and more vigorous oversight into the process.
Help for blighted budgets
For the sake of accuracy, it may be best to call TIF a municipal revenue development tool. Federal money in the form of grants for urban redevelopment and tax breaks on municipal bonds began drying up in the 1970s, and unfunded federal and state mandates have increased.
In its primer on TIF, the Illinois Tax Increment Association explains the need for the tool this way: "Factor in state imposed property tax caps, and the funding problems facing local governments make it obvious that local governments are left to do more with less." In California, more than half of the TIF-administering agencies in the state were created after the tax-capping Proposition 13 was passed in 1978.
TIF is attractive to local governments for several reasons. It provides immediate funds for economic development and infrastructure, and it offers the possibility of long-range revenue from an expanded tax base. Mayors also know that a TIF district set up in a booming or about-to-boom area could return much more money to city hall than was needed to pay off the city's investment in the area.
Municipalities also use TIF to stimulate retail development. Such projects rev up the sales tax on which municipalities increasingly rely to pay day-to-day bills. However, that means other taxing bodies must defer their share of property taxes. By using TIF to subsidize retail, municipalities in effect get schools and parks to help pay for municipal operating budgets.
What began as a tool to heal blighted downtowns or factory sites became a tool to heal blighted municipal budgets. TIF diverts money that might have been spent on public services into the pockets of developers and retailers. It subsidizes big national retailers at the expense of local businesses. It creates massive new revenue flows to city halls, but reporting requirements and oversight are often so lax that the public can't learn where their tax dollars are going.
Critics are asking some questions to which the answers are not yet clear:
—¢ Does TIF overpromise and underdeliver? Most cities surveyed in recent years confirm that property values in their TIF districts increased as promised. Only a handful reported actual declines in value.
However, the underlying economic factors common to all development projects —” location, markets, local prosperity, and the like —” must be as sound in a TIF-assisted project as in any other, perhaps more so. TIF in Iowa, concluded Iowa State University economists Dave Swenson and Liesl Eathington in 2006, "works best by a large margin in the state's booming suburban and metropolitan communities and has had only lackluster results at best among many of its struggling medium sized cities."
Nonetheless, flat-out financial failures are rare. In general TIF bonds are rated as sound investments. But while many TIF-backed projects do well enough to at least cover bond expenses, they often fall well short of the projections of backers. Studies in various cities beginning in the 1990s show that increased retail sales in TIF project areas usually come at the expense of sales in other parts of the region.
—¢ Is TIF too often used where it is not needed? Reliance on TIF to generate new revenues has meant that TIF may be used not where it is most needed, but where it is likely to generate the most new revenue. Most state laws define blight generously, with the result that almost any kind of project can qualify for TIF. (A trout stream near Pittsburgh was declared an "economically or socially undesirable" land use so the property through which it ran could be TIF-ed. Baraboo, Wisconsin, designated a cornfield and an apple orchard "blighted" so that Wal-Mart would qualify for TIF to build a supercenter on the site.)
Awarding TIF to projects in such areas fails the "but for" test —” the clause in most TIF statutes that demands TIF be used only if the anticipated growth in property value at the affected site would not happen but for the availability of TIF capital. The problem is that establishing whether development would or would not have happened but for the TIF designation is hard to do.
Swenson and Eathington of Iowa State University concluded in last year's report: "None of our data can sort out what growth would have occurred in growing areas regardless of the use of TIF incentives, nor can it tell us what growth would have left had TIF resources not been utilized."
In Kansas City, a cost-benefit analysis must show that the economic benefits flowing to the city and other taxing districts as a result of a proposed TIF project are greater than the costs. But local officials usually lack the data or the expertise to compute how much growth might occur without a TIF project area.
In 2002 the Neighborhood Capital Budget Group —” a coalition of 200 Chicago organizations that studies local public investment —” found that in all 36 of the TIF areas they studied, property values were rising during the five years before designation. The group projected that of the $1.6 billion in new property tax revenue that the city of Chicago would capture over the 23-year life spans of these TIF districts, $1.3 billion of it would have been raised anyway, assuming the areas continued growing at their pre-TIF rates.
"The bottom line," the NCBG wrote, "is that the city invested $1.6 billion for $300 million in revenue growth."
Richard Dye, a Lake Forest College economics professor who is a specialist in public finance, notes that the finding of whether a proposed TIF-assisted project meets the statutory blight and but-for tests is merely a pro forma exercise. Whether that determination is made by in-house planners or economic development staff (in larger cities) or private consultants, Dye says, "It's hard to see how it passes the straight-face test."
—¢ Is TIF a bargain for cities? In several states, the practice is being overused by municipalities that want to draw on TIF revenues instead of needed, if unpopular, tax hikes. The group 1000 Friends of Wisconsin found that two of five of the more than 300 municipalities in that state with at least one TIF district in 1999 had more of the local property base under such districts (measured as a percentage of total property values) than state law allowed.
Critics warn that overuse can become misuse. They argue that investing in sales-tax-generating development in particular may be more expedient than wise. They note that because sales tax revenues are more volatile than property tax revenues, financing TIF debt is riskier and thus more expensive. Subsidizing a retail development with TIF revenues gives it an unfair advantage over its competitors, especially local businesses.
And what is good for a TIF-administering body's balance sheet is not necessarily good for the larger economy. As the Brookings Institution concluded in 2003 about TIF districts in Missouri, "The inclusion of sales tax base in the program tilts it toward lower-wage jobs and retail projects, which rarely bring new economic activity into a region."
Iowa State economists Swenson and Eathington found that some city officials they spoke to regarded TIF as a source of general-purpose revenues that could be used on activities not explicitly authorized by the founding statutes. To secure it, cities are putting more and more taxable land into TIF zones.
Peter Fisher, research director of the Iowa Policy Project, voices some misgivings about the trend. "Iowa's law has become quite lax," he says. "It is now possible for a city to TIF the entire city, and if they got their foot in the door before 1995 with even a small TIF, the TIF area can be expanded to cover the entire city."
Are local officials slowly killing the goose that lays golden eggs? Thomas Luce, author of the Brookings study on Missouri, has pointed out that if TIF subsidies are made available everywhere —” and trends suggest they will be sooner than later —” the availability of TIF confers no special advantage to any one place. About one-quarter of Chicago's taxable real estate is subject to TIF diversion.
The bestowal of TIF subsidies ignores mounting studies that conclude that location, location, location really is what matters, that local incentives have very little effect on business location decisions, and that decaying downtowns and closed factories are the result of factors beyond the ability of the most adroit public financing to repair.
A new basis for planning?
TIF-assisted development is still development, of course, and as such has planning as well as fiscal implications. It is widely blamed for subsidizing sprawl in the suburbs and urban fringes and for accelerating gentrification in cities. Both indictments are probably overdrawn.
Most state enabling legislation requires that TIF plans conform to existing comprehensive plans. "Considering TIF requests outside of a comprehensive planning framework is ad hoc planning at its worst," says Ryan Horton, a researcher and urban planner for the Public Policy Forum, a Milwaukee nonpartisan public policy research organization. (Of course, many municipalities, particularly smaller ones, lack comprehensive plans, in which cases TIF projects are constrained only by zoning codes and regulations.)
Rachel Weber of the University of Illinois has made a study of tax increment financing. She says laws requiring comprehensive plans don't make much difference. "Comprehensive plan requirement in the statutes is not followed much," she says. "It doesn't decide which TIF projects get okayed and which do not."
The comprehensive plan keeps inappropriate development out, but a well-planned and administered TIF project can make appropriate development happen —” by offering incentives for specific kinds of investments in specific areas. "TIF provides planners and local governments with lots of flexibility and money to implement projects," says Weber.
Peter Skosey, a planner who is now vice president of external relations of the Chicago-area Metropolitan Planning Council, has served as the public member at the joint review board that considers TIF proposals in Chicago. "It's a tool to shape and channel market forces to locate retail along certain corridors, or housing near transit stops," he says.
In short, not only is the comprehensive plan a constraint on TIF misuse, TIF incentives can be a tool to realize a comprehensive plan. In Dallas, a proposal earns points on a numerical scale for the degree to which it provides a dozen public benefits such as green space or affordable housing. "A policy like this," says Horton, "could be used in conjunction with a comprehensive plan."
One risk is that a city plan can become not much more than the sum total of its TIF projects. "What I fear is that any comprehensive planning can get held hostage to all these little fiefdoms," says Weber. "TIF project areas become in effect the new planning jurisdiction rather than the municipality."
There is also a risk that routine infrastructure investment will go to where the TIF is, rather than being given a priority through normal budgetary and planning policies.
Wisconsin is only one of the states in which TIF project plans are drawn up by the city plan commission, which holds a public hearing and recommends the district boundaries to the city council or village board. Blight and but-for determinations also may be based on studies drafted by municipal planning staff. In other states, planning for projects within TIF districts often is done by public-private entities set up for the purpose or by planners working for private consultants hired to draft redevelopment plans.
"Planners are ideally placed to review TIF proposals," says Horton, "but only if they have done the heavy lifting first —” that is, initiated a comprehensive planning process spelling out economic development spending priorities, strategies, and goals for the entire municipality."
Just a tool
After a half-century, certain truths about TIF have emerged. One is that it is not a magic wand that can bring a dead lot or neighborhood back to life. "Policy makers should use TIF with caution," note Richard Dye and David Merriman of Loyola University of Chicago. "It is, after all, merely a way of financing economic development and does not change the opportunities for development or the skills of those doing the development planning."
TIF is not ideal for all development chores. Weber and colleague Laura Goddeeris in a recent paper list big box retail (which can cannibalize sales from stores elsewhere in town or the region); low-density development such as housing in urban areas (which has trouble paying for itself and often adds to the costs of schools and parks); and business attraction and retention incentives (to the benefit of companies, which don't always stay put, rather than land, which does).
"If TIF is not used more discriminately," they write, "its increasing popularity may only lead to more fiscal fragmentation, giveaways to the private sector, and spatial inequities in public resource allocation."
TIF is like any other tool, useful or harmful according to how it's used. "I was at a presentation when someone held up a colander," recalls Weber. "They said, 'Use it as a rain hat and it doesn't work very well. Use it to drain spaghetti and it works just fine.'"
James Krohe Jr. is a Chicago-based freelance writer.