A Legislator Demystifies Tax Increment Financing

August 23, 2013

(For the use of the membership only)

by Greg Walker

For decades, Indiana has utilized tax increment financing (TIF), an instrument by which future property-tax revenue is captured to pledge for borrowed funds for capital investment. It nonetheless remains controversial. We need to ask why.

Debt, or leverage, is a simple idea, and businesses employ this decision model routinely to weigh the risk and reward of borrowing money to make capital investments with the expectation that increased utility or efficiency will generate incremental (marginal) revenue. Businesses employ various forecasts to determine the probability of hitting projected growth targets, and decide to borrow or not borrow based on the cost of money.

Easy, right? The problem, some point out, is that TIF doesn’t work like this business model.

It is true that, generally speaking, civic leaders listen to proposals from community members who seek public money to partially or fully finance public works that will create incremental value for the community in total. That value is reflected in increased value of land and property, sufficient to pay back the tax bonds and ultimately grow the assessed valuation base for the entire community. The taxpayer wins with enhanced business opportunity, and the taxing authority wins with new marginal revenue down the road.

The controversy, however, lies in the risk-reward analysis. In the business model, the investment risk is borne by stockholders or business owners, as is the potential for higher returns. This is not so for public investment in TIF projects, or at least (the risk-reward analysis) is not so easily quantified.

How much new business could a downtown barber expect if the major employer hires a third shift based on a project financed 50/50 with TIF money? Will the barber ever know if the pickup in haircuts was due to his or her property taxes being diverted from paying for school buses or police cruisers and spent on a new public aquatic center?

This is the point: Quality of life cannot be measured strictly in dollars and cents. We should therefore avoid business analogies when discussing priorities in public finance and the role of government.

California introduced TIF and redevelopment commissions to the free world and, in 2012, came full circle to eliminate them. The state of California is bleeding revenue and, even worse, its businesses and human capital. Would it not be worth our huge investment in time to analyze each TIF project, and decide in hindsight whether each one in total contributed to California’s growth or its decline?

Finding New Money

This writer and at least a few other legislators believe TIF has strayed too far from its initial function. Let me outline some obstacles and at least three corrective measures if TIF is to continue to be utilized in Indiana.

When organic growth in cities and towns and school districts has slowed or even begun to decline, the slowdown reveals how government budgets historically grow at a rate faster than community growth. It can be argued that every level of government is guilty of trying to conceal with new money these increased costs, this gap.

This new money can be obtained by annexation, or tax increases, or borrowing, or as a result of inflation, though none of these are without increased cost for services provided or of lost opportunity cost.

Mayors and other local officials may be concerned there will be no new money without tax incremental financing. Property-tax caps contribute to this paradigm.

What happens when redevelopment commissions decide that all of the tax-collection increase over the original base value should not transfer to the general fund for regular public services? Wouldn’t a rate reduction for all taxpayers unit-wide be one manner to provide some return on investment to those individuals who cannot otherwise quantify any benefits for having their own property used as debt collateral?

So any citizen who raises questions about the return on a public asset runs the risk of being vilified as an “anti.”

The Public Good

We should talk openly about the public component of some of the projects that TIF is purchasing. Why should hoteliers put up their property as collateral for loans to build new hotels with which they must compete? Even if the collateral is for only half of the financing?

It is difficult enough to compete against investments in which a property-tax abatement has been offered in exchange for “new” money. It is harder to bear, though, when your own taxes carry the additional cost of traditional services extended because of the new investment, and where all that incremental property-tax collection is financing the debt service on the competing project.

Lost is the concept of what entails a public good or public investment. If you appreciate the original intent of TIF , in particular for property redevelopment, you will know greenfield investment was initially excluded. Originally, a blighted area would remain blighted as long as other parts of town were less costly to develop.

It may be true that citizens collectively bear the price of an eyesore in the middle of town subject to years of neglect because of site-preparation costs. But does the taxpayer equally benefit when targeted project investment does not create infrastructure that encourages voluntary private capital infusion?

Being a member of the Senate Economic Development Committee, I still cringe at every tax credit or incentive or grant opportunity that demands a business case be made before a board of commissioners or legislators or appointees.

I know these groups are generally motivated to be responsible and make the right decisions regarding job opportunities. Nonetheless, I cannot help but think how inadequately equipped any board or committee is to identify the correct investment, the investment that actually pays handsome returns.

Businesses take that risk, and most of them fail. What, though, is the failure rate for TIF-project selection? I wonder.

One argument is that appointed boards can make investment decisions that elected officials cannot endorse for fear of the political ramifications (as if that were a positive attribute). But who asks for this justification after the fact, after the decision has been made to spend? Lenders hold debtors accountable, but not the public officials themselves. In fact, I am not aware of how anyone could prove the growth and vitality in any community can be attributable to the utilization of TIF.

With so many factors in the decision to invest, so many variables at play, in so many economic arenas nationally and internationally, the “but for . . .” argument is impossible to substantiate. It is therefore largely ignored because of how impractical the task is of proving the negative.

The decision should be simpler, based on the collective desire to borrow and finance, not the argumentation of a small influential class set to receive great potential benefit from so-called public spending. Again, it is unfortunately easier to question the motives of the doubters than to make an actual economic case.

Decisions Inside a Silo

I raise one final question: Why do the other units of government, all subject to a tax-cap regime, not become more engaged on the question of TIF?

Currently, we are making decisions inside a silo, piling up spending and debt with dedicated funds as if they were new revenue streams. We should recognize that they are funds diverted from paying down existing obligations.

As an alternative, would not public consideration of TIF project “A” be the best opportunity for other levying bodies to rise up with their competing arguments to invest in their project “B” or “C”?

The answer may be that we in government all fear being stigmatized or labeled. It might also be that we fear payback if one government unit were to suggest another project had less public merit than their own. We all want everyone else to eagerly jump on our bandwagon when it is time to consider the investment opportunity we would prefer.

Ultimately the public must determine the priorities of a community. Considering how to spend tax dollars inside that silo only makes this process less efficient.

Conclusion

I offer three recommendations in closing:

• Cap the total assessed valuation in any given geography employing TIF so that less duty falls on the possibly declining taxpayer base to pay for growing service burdens.

• Return the statute to its original purpose of public good with shared communal benefit rather than targeting investment that enriches a small subset of the tax base.

• Engage all levying bodies in the conversation — openly and publicly — so that Jill and Joel Citizen can more easily consider public-spending options fairly. Then a community can set its priorities for the best use of scarce or even declining funds. The duty falls on elected leaders to gather that more informed public opinion while educating the yet uninformed, not treating them like the unwashed. Not all opinions are equal in merit, but all taxpayers should have equal opportunity to contribute their thoughts. This is the job of an elected leader — making decisions with the best information available in an open fashion .

In sum, these are modest conceptual solutions; I entertain any idea that would further simplify this financing so the focus returns to the nature of the economic-development project and its civic priority.

Whether other legislators believe the root of the problem with tax increment financing is crony capitalism or innocent inefficiency in decision-making, I hope they support at least these baby steps to restore some confidence in public financing.

Greg Walker, Columbus, has represented District 41 in the Indiana Senate since 2006. He holds an MBA from Wesleyan University with an undergraduate degree from Indiana University in business finance. Walker, who sits on three committees pertinent to this subject (Commerce, Economic Development & Technology; Financial Institutions; and Tax & Fiscal Policy), is a senior consultant with Proffer Brainchild Analytics Innovation. He wrote this article for the foundation.

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