Keating: A Critical Review of TIF and Abatement

July 24, 2013

by Maryann O. Keating, Ph.D

The Wall Street Journal recently listed penthouses available for sale at $2.1 million or more at Philadelphia’s “most prestigious address.” Units were designed by an award-winning architect and are located in a fully staffed building with five-star concierge services. Each sale includes a 10-year tax abatement.

In March of this year, it was reported that the city of Philadelphia mailed new valuations to owners of 580,000 parcels. One owner found that his property, assessed at $86,000 in 2008, was now assessed at $575,000 with taxes due potentially exceeding $7,000 annually.

There remains a large group of people who have never been able to understand the logic underlying property-tax abatement. Police, fire and government operations need to be financed through property taxes or government debt. In new developments, streets, sidewalks and curbs must be constructed. How can certain properties be released from taxes without raising the taxes of all other property owners in the community?

The reason for property-tax abatements, we are told, is the need for local government to play an active role in encouraging certain activities. In Indiana, tax abatements can only be granted for projects located in an “economic revitalization area,” so the government must first define and establish such an area. For example, Indianapolis officials evaluate each applicant for tax abatement and forward their recommendations to the Metropolitan Development Commission.

Assessed value and, hence, property taxes are expected to gradually increase on improved property. This, of course, assumes that there is a market for improved property. Abatements represent a reduction or exemption from taxes for a specified period. The maximum abatement permitted in Indiana exempts all taxes due in the first year because of any improvements followed with reductions in subsequent years;  in the 11th year, no deductions remain.

The assumption is that improvements to certain properties would not occur in the absence of abatements; therefore, in the long run, future property-tax revenues, employment and local income-tax revenues should increase. There is a real cost, however, to the general public from tax abatements, namely, forfeiting increased taxes that may have been generated without abatements.

Tax Increment Financing (TIF), an alternative to tax abatement, captures a percentage of the real property taxes paid by the property owner due to an increase in site value. However, captured tax revenue, referred to as tax increments, does not flow into the general revenue stream of the municipality, county or township within which the TIF is located. Tax increments remain in the district to be used at the discretion of local economic-development commissions to finance public or private projects. Essentially, a TIF is borrowing based on expected increases in property-tax revenue. When a project is completed and bonds repaid, a particular TIF is expected to expire and all property taxes redirected to local government.

Local government officials, confronted with municipal-bond restrictions, state-imposed caps on property taxes, reduced federal funding and aggressive lobbying by private developers find such incremental tax financing attractive. California has discontinued incremental tax financing, but Indiana and all other states, with the exceptions of Arizona and Wyoming, have legislation enabling TIFS.

TIFs are sometimes viewed more favorably than tax abatements because property owners actually pay taxes on increased property values. However, when the cost of basic government services increases, the result is a general revenue shortfall paid from sources outside the TIF district. Meanwhile, incremental tax revenue is allocated by commission members who are not necessarily elected representatives.

Forty percent of the city of South Bend’s geographical area is located within Tax Incremental Fund (TIF) districts. In addition, St. Joseph County, in which South Bend is located, has three TIF districts and is considering another two. It is conceivable that some TIFs, whether successful or otherwise, will never be dissolved and additional tax revenues never flow into general funds to provide essential services.

It is the case that incremental taxes in some TIF districts could be made available in the future for police, fire and other essential government operations. For example, existing funds derived from South Bend’s Erskine Village TIF are sufficient to retire all remaining debt and close 20 years ahead of schedule. However, the commission must notify the state if any funds are either used for early payment of bonded debt or dispersed outside the TIF into general local government revenue.

Corrections are being proposed. Dr. David Varner, a member of the South Bend Common Council, recommends that, in addition to requiring the release of some TIF funds on an annual basis, the time horizon of new TIF districts be limited to years to maturity on bonds issued to pay for a TIF’s initial development project. He suggests that the Indiana General Assembly address statutes on TIF length.

Maryann O. Keating, Ph.D., a resident of South Bend and an adjunct scholar of the Indiana Policy Review Foundation, is co-author of “Microeconomics for Public Managers,” Wiley/Blackwell, 2009.



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