Wednesday, December 30, 2009
Standard Article by Brett Narloch
Issue: Taxes
Tax increment financing (TIF) is a widely misunderstood "economic development" tool that local governments can use to renew their downtown areas or to increase property values in a core area of a city. It was born out of "urban renewal" concepts that were developed in the 1940s and 1950s. California was the first state to pass TIF legislation, in 1952. It was passed by the North Dakota Legislature in 1973.
The concept of urban renewal centers on redeveloping slum and blighted areas. All across the country, city governments took property using eminent domain and other means to demolish buildings and other structures to redevelop them.
One of the tools that became popular was tax increment financing. When a municipal government wants to fund a development project using tax increment financing, taxable valuations of properties in renewal areas are frozen. In subsequent years, the property taxes paid on any additional taxable value are not put into the general funds of cities, counties, school districts, or park districts; rather it is put into a tax increment fund. The money in the fund is then used to pay for costs associated with the approved redevelopment of the renewal area. A city can enter into agreements with developers to redevelop the public or private property.
In North Dakota, tax increment financing falls under urban renewal law and was put into the North Dakota Century Code in 1973. Since its passage, the legislature has amended the tax increment financing law three times (1983, 1985, and 1989). When it was first passed, projects that were eligible to be funded using tax increment financing were limited to areas that were declared "blighted" or a "slum," which meant that the areas had to be declared to be detrimental to the health, safety, and welfare of citizens.
However, like with most government programs, mission creep set in and TIF started being used for more than simply redeveloping blighted areas. Writing for the National Association of Realtors, Dr. Craig Johnson of Indiana University wrote:
"Though originally created for the limited purpose of financing the redevelopment of blighted communities, TIF has developed into an integral part of the revenue structure of local governments across the nation. The rapid growth of TIF as an economic development technique of choice to finance land acquisition, site development, property rehabilitation, road improvements, water and sewer expansion, and building expansion, began in the early 1980s."
The same happened in North Dakota. In 1989, the legislature added to tax increment financing law by expanding the types of projects that tax increment financing could be used for. After the amendment passed, cities could use tax increment financing to simply develop commercial and industrial properties.
While tax increment financing is a way to redevelop properties that are not well-kept or have not been increasing in value, it leads to unnecessarily high property taxes for most property owners and corruption.
Property Taxes
In 2009, the state temporarily reduced property taxes by buying down school district mills with a big projected state budget surplus. The relief plan ends after four years when property owners will be subject to dramatically increased school mills. In the meantime, other local government entities will not be bashful about raising their mills which will cause long-term problems.
Clearly, the need still exists for permanent property tax reform. Many proposals have been put forth, ranging from limiting property taxes to a certain percent of a property's value to simply eliminating property taxes altogether.
Since tax increment funds rely on property tax revenue, eliminating property taxes will also end tax increment financing. But, if any other property tax reforms are to be taken seriously, they must include an elimination of TIF because it simply keeps property taxes high for most property owners while subsidizing a select few.
For example, City A has a tax increment fund, and City B does not. They each have an annual budget of $500,000 and properties that were perfectly equal in number and in value. Since City A has a renewal area, the tax increment ($50,000) for the properties located in that area goes to a tax increment fund instead of to the local tax jurisdictions (i.e. school district, city, county).
That $50,000, then, could not be used as general fund dollars used to pay for police, fire protection, sewers, schools, and other functions of local governments; rather, it is set aside for a group of selected members to administer for approved projects in the renewal area. The tax increment fund money can be used to improve the outside of buildings in the renewal area instead of providing police protection.
Staying with the example above, property owners in City A will have to make up that $50,000 because general fund revenue for local jurisdictions would only equal $450,000 ($500,000 was assessed, but $50,000 was put into a tax increment fund instead of the general fund), which means that property taxes would be 10% higher for property owners in City A than City B.
Besides keeping property taxes higher for most property owners, tax increment financing is an inequitable way of spending property tax revenue because it allows private people and businesses to use a portion of their property taxes paid (the tax increment) toward developing their property or the infrastructure directly around it. It's like a typical property owner using his property tax money to fund the repaving of his driveway or sidewalk or residing his house. Of course, that is not the case for the average property owner. Their money is pooled into the general funds of the taxing jurisdictions.
NDPC Land Use Policy Fellow Randal O'Toole wrote:
"City officials sometimes claim the development pays for itself. The reality, however, is that the tax increment would normally go to schools to educate children living in the development; to water and sewer, fire and police, and other public costs of the development. Since the TIF siphons these funds away, taxpayers in the rest of the community must pay for those schools, water, sewer, fire and police, and other urban-services needed to support the new development."
If property owners in the renewal areas are able to use a portion of their property tax dollars to fund the development of their immediate area, why can't all property owners?
Developers get another tax break, as well. According to O'Toole, "when the city sells bonds, the developer also get to take advantage of tax-free municipal bonding, which costs less than if the developer had to sell bonds itself."
Since commercial and industrial property owners who are not in the renewal areas are forced to subsidize the redevelopment of those areas, they are actually being forced to subsidize their competition.
Moral Hazard and Corruption
Not only does tax increment financing make little economic sense, it also opens the door to moral hazard and corruption. O'Toole wrote, "The easy availability of TIF money create moral hazard for developers. With so many developments getting tax subsidies, what developer would be willing to invest in a project without such subsidies?"
Since city politicians write the boundaries of renewal areas and write the contracts between the city and private developers, it becomes too easy for politicians to give good deals to favored developers or interest groups.
On the other side, it allows developers to acquire property in a renewal areas specifically because their buddies in City Hall are ready to give them a nice redevelopment contract. In fact, favored developers could be able to get corrupt politicians to either rewrite the boundaries to include a buddy's property, or buy properties feeling confident that they will be able to get their friends in city government to rewrite those boundaries.
Conclusion
Tax increment financing is a tool used by cities to increase economic development in underdeveloped or blighted areas. It was originally intended to redevelop truly blighted areas, however, is now being used simply to lift property values so cities can collect more property tax revenue.
The subsidies given to favored developers inflate property tax bills for property owners that live outside the renewal or TIF areas. It also forces business owners to subsidize their competition and can become merely slush funds for city politicians to pay off interest groups or give breaks to favored developers.
When discussing real property tax reform, legislators would be wise to consider how tax increment financing keeps property taxes higher for the average property owner than they need to be and abolish tax increment financing.
