Tax increment finance districts are important financial tools communities use. Their use has grown steadily, but they are complex and, as a recent study points out, municipalities put themselves at risk if they create and manage them haphazardly.
Neighborhoods, roads, water treatment, power lines, police stations – infrastructure – is expensive to build and maintain.
Sometimes communities can bump sales or property taxes to pay for improvements, but as state budgets worsen and taxpayers become more reluctant, new ways to pay for infrastructure improvements are needed.
In the 1950s, cities began using a financial instrument to sell bonds based on anticipated tax revenues that infrastructure improvements would generate. This was tax increment financing.
The trend began very slowly, notes Josh Pacewicz, a Brown University researcher who wrote “Tax Increment Financing, Economic Development Professionals and the Financialization of Urban Politics.”
Originally, tax increment financing was a funding mechanism of “last resort” for “blighted” communities. In 1952, only a few states allowed tax increment financing, but by 2007, 49 out of 50 states used them.
Concurrently, municipalities and private entities began working together to build infrastructure projects. While cities once commonly built hospitals, housing or roads by themselves, the study noted, “now public-private partnerships are often formed, with risk and reward being spread between the municipal and private parties.”
DeKalb has two tax increment financing districts and is considering two more, one along South Fourth Street and another on a small part of Sycamore Road. The DeKalb City Council will have a public hearing on establishing those TIF districts on Aug. 12.
Why tax increment financing seems to work is part of its complexity.
As Pacewicz notes, cities issue two types of bonds: general obligation and revenue bonds.
“General obligation bonds are backed by a city’s property tax base and because a city is legally obliged to repay them, are counted by rating agencies as debt. In contrast, revenue bonds are not backed by a city’s property tax base and therefore do not impact a city’s credit rating.”
TIF-backed securities are based on future revenue, and they receive more favorable ratings from credit agencies, Pacewicz said, but the really interesting part of his study is that the research is based on two Iowa cities. The cities were referred to as “River City” and “Prairieville” (keeping the actual names of places and people anonymous is common in academic research).
TIFs caused trouble in River City, so as Barb City considers establishing more TIFs, here are some cautionary findings from Pacewicz’s study:
Overenthusiastic projections on future tax receipts are routine, and tax increment financing use is typically accompanied by large and mounting debts. TIFs create “a structural opening for a new kind of urban actor who is capable of acting simultaneously as an insider and an outsider: A city representative not formally tied to the city.”
Such development professionals play “dual roles of stewards of municipal finance and central leaders within development initiatives.” Because developers’ reputations depend on successful outcomes, “they become invested in these solutions, which are frequently expensive.”
Politicians in River City and Prairieville expressed concern that tax increment financing was “corporate welfare,” that it produces unsustainable debt, and that repaying it diverted crucial resources.
Frequently, city leaders don’t understand TIF mechanics and can’t accurately gauge the success of development professionals.
The desire to find creative solutions also leads development professionals to develop new TIF-like instruments. In many states, for example, cities have begun to securitize projected sales tax receipts and create structured bonds backed by this revenue stream in addition to projected increases in property taxes.
• Jason Akst teaches journalism and public relations at Northern Illinois University. You can reach him at firstname.lastname@example.org or follow him on Twitter (@jasonakst).