The Implementation of Tax Increment Financing

The Implementation of Tax Increment Financing as an Economic Development policy

By: Randy L. Jacobs, J.D.

ABSTRACT: With Tax Increment Financing (TIF) a municipality pays for economic development expenditures out of future increases in tax collection. The TIF method has achieved widespread popularity as a funding source to finance local infrastructure investment and improvements; however the TIF program has several shortfalls and many critisms. This paper will focus on the criticism that TIF programs are too costly to implement. Critics say this is due to the complexities involved in the implementation process (Todun & Yakolev, 2002). This paper will also test the proposition that by implementing the TIF program in accordance with a different theory for the implementation of public policy than that currently employed by states which utilize TIF. The complexity of the implementation process will be greatly reduced along with the cost of the implementation process.

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INTRODUCTION

Background

To revitalize deteriorated sections of many urban areas at a time of declining federal grants-in-aid for urban redevelopment, many states have adopted a variety of innovative mechanisms to help stimulate economic activities within specific geographic boundaries (Mann, 1999). One such mechanism gaining increasing popularity is Tax Increment Financing. TIF is an economic development policy tool that allows a municipality to designate an area for improvement and then earmark any future growth in property tax revenues to pay for economic development expenditures (Dye & Sunberg, 1998). If all of the future growth in property tax revenues taxes within the district is clearly and fully caused by the TIF-funded improvements, then TIF is simply an accounting device wherein projects pay for themselves over time (Dye & Sunberg, 1998).

TIF originated in California in 1945 with the enactment of the Community Redevelopment Act (Todun & Yakolev, 2002). It was first adopted as a local revenue source designed to eliminate blight, expend housing opportunities and create jobs throughout communities in California (Todun & Yakolev, 2002). Although it originated in the 1950s, it was not widely adopted until the late 1970s. According to a survey conducted between 1986 and 1987 by Klemanski (1999), 55% of the 33 states with TIF legislations passed these legislations between 1974 and 1979. By 1970, only seven states had authorized the use of TIF. These states are California, Minnesota, Nevada, Ohio, Washington, and Wyoming (Klemanski, 1999). Klemanski (1999) argues that the recession in the mid-1970s is a major factor in these TIF adoptions. Several TIF-enabling legislative actions took place during the period from mid-1970s to late 1980s. This period also coincides with a significant decrease in federal aid to state and local governments (Klemanski, 1999). Between 1975 and 1990, federal aid to state and local governments as a percentage of GDP went down from 3.2% to 2.4%, a decrease of 25%. Federal aid in 2000 was still below its 1975 level. Initially, TIF aimed at financing a variety of infrastructure improvements for economic development and growth. Today, this original goal can be extended to include lower unemployment, higher wages, higher property values, business attraction, industrial development, downtown development, overall infrastructure improvements, and increases in local tax revenues (Todun & Yakolev, 2002).

Numerous policy issues have been raised in the analysis of TIF. Before identifying and discussing these issues, it is necessary to review briefly the designation process of a TIF program. Typically a municipal government identifies and designates a specific geographical area, usually a blight or deteriorating area, as the TIF district. Most states require the establishment of "blight" or "slum" conditions as a prerequisite for the designation of an area as a TIF district (Man, 1999). The creation of the TIF district assures private investors that their property taxes are used to pay for infrastructure needs and development expenditures in the district which directly benefit their business, rather than to pay for the general cost of local government services (Man, 1999). In the absence of TIF, these costs would be borne by these investors. Once the district is established the municipality freezes the assessed valuation of all parcels in the designated area for a number of years (Man, 1999). Local taxing jurisdictions that have taxing authority with the designated TIF district, such as the county, township, and school district continue to collect property taxes levied on this frozen tax-base. Taxes derived from the increases in assessed values (the tax increment) resulting from new development, in the TIF district, go into a special tax increment fund to pay for the necessary public infrastructure, investments, and improvements (Man 1999).

Figure 1: Stages of the Standard TIF Process

The TIF process operates until all the projects are completed and all the debts incurred by the city to cover the costs of public improvements have been repaid (Man, 1999). When the district is dissolved, the amount of the property tax based on the full increased assessed valuation of the area is returned to all taxing bodies (Man, 1999). In this way, TIF has been described as a technique to disperse the cost of development to those government agencies that will benefit from the increased tax base that a TIF project will generate (Paetsch & Dahlstrom, 1990).

Proponents of the TIF mechanism claim that such programs have made significant contributions to local economic development. First, TIF can provide significant capital to some types of development projects that are economically feasible but would not have occurred without TIF (Man, 1999; Todun & Yakolev, 2002). Second, TIF programs have worked as a strong unifying force in the economy, which induces normal antagonists such as: developers, neighborhood groups and local government officials to form a public-private partnership to deal with urban problems and to restructure the otherwise deteriorating areas (Man, 1999; Todun & Yakolev, 2002). Third, TIF district development may create economic growth both inside and outside the TIF district, especially if the development is industrial or commercial (Todun & Yakolev, 2002). The market value of the property tax base of both the enacting and overlapping governments may increase (Man, 1999). In addition,