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March 2012 Policy Study, Number 12-4

   

Tax Increment Financing: Magical Tool or Moral Hazard?

    Executive Summary
   

 

Local and city governments have used tax increment financing (TIF) since the 1950s to promote economic development. Following California’s adoption of TIF in 1952, 48 states allowed TIF districts by 1997. Currently, only Arizona does not have a TIF provision.[1] It is “the most widely used local government program for financing economic development in the United States,” according to many tax scholars.[2]

 

TIF areas are supposed to be “blighted” or otherwise unattractive to investors and thus in need of government support to become productively “developed.”

 

When a city or county establishes a TIF district, the property taxes allocated to various other governments, such as school boards, are frozen at the current, blighted level. The government implementing the TIF then focuses on increasing the desirability of the property in the TIF district to private-sector investors by upgrading infrastructure such as roads, water, and sewer systems.

 

Ideally, after the upgrades to the infrastructure, new private-sector development would decide to build and run its businesses in the TIF district.[3]

 

Currently many cities have expanded from basic infrastructure development to offering tax rebates to selected businesses, buying and selling the land themselves, offering incentives to businesses by paying for site preparation and construction, building new facilities and leasing them, and establishing community centers or police/fire stations.

 

According to a “Best Practices Reference Guide,” it is also appropriate to use TIF tax money for park improvements, landscaping, environmental remediation, bridge construction, parking structures, libraries, and schools – based on the premise that these infrastructure improvements would attract new economic development in a TIF area.[4]

 

The goal is for property taxes levied in the TIF district to go up because of the economic development. The new property is re-assessed and increased taxes are collected.

 

The difference between the original property taxes and the new taxes is the “increment.” This money is used by the city to pay for the infrastructure improvements that enticed the economic development.

 

However, the ancillary governments such as school systems and counties do not receive the new money as they normally would. This money all stays with the government establishing the TIF.

 

In Iowa the money from TIF areas can also be used in rural development zones and for job training programs by community colleges (Industrial New Jobs Training, Chapter 260E, Code of Iowa).[5]

 

Though a TIF district can be run on a cash basis, most cities issue bonds. The money from the bonds is used to pay for the upgrades, land, and buildings. Then the tax increment after development is used to pay back the bonds.

 

If normal infrastructure bonds were issued outside of a TIF district, they would generally have to be approved by a taxpayer vote, and receive 60 percent or more support. The property taxes of all citizens would be increased to pay for the bonds. Following development, the increased property taxes from the new appraisals would be divided among all taxing authorities, as normal.

 

TIF systems are widely considered a “perfect closed system of self-sustaining finance” because they pay for themselves by “increasing the tax base.”[6] They are sold to homeowners as having no impact on their property taxes, as basically “free money.” In voicing his support for this method of funding, the mayor of Sacramento, California, recently called TIF projects “magical things.”[7]

 

However, as Americans have learned over the past five years – all financial decisions, even magical things, involve risk. Not every project or idea is a success just because one wants it to be. There is no free money. Possibly the TIF area had not been developed by the private sector in the first place because the market had decided the area was undesirable; there was no demand for X business or X building in that area.

 

Additionally, a TIF district might encourage “unproductive investments” with a negative end result.[8] Resources of both the city and the private sector could be misallocated because of the encouragement offered in the TIF district. Though the city mayor, council, or manager thinks a new hotel, restaurant, or office building is needed, maybe it is not. This is considered by economists to be a “moral hazard,” or systemic encouragement to act in a “detrimental manner” without intending to do so, because of a contractual incentive.[9]

 

As a result of changes to the Iowa TIF law in 2009, which require the increased TIF property taxes to be tracked and reported separately, the magical thing of TIF is now being conducted in a more transparent and open manner.

 

The potential moral hazard of TIF is becoming apparent. Many people, both taxpaying citizens and elected officeholders, are asking questions about TIF benefits. In many ways the questions reflect the local impact of negative bailout and crony capitalism decisions at the national level. This policy study will review the current TIF situation in Iowa.

 

   

 

Click here for pdf copy of this Policy Study

 

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