Municipal fiscal stress and the use of Tax Increment Financing (TIF)

Abstract

The Lead Paper in this policy and practice discussion begins by describing the current fiscal conditions of American cities and the constraints they face in financing both operation and capital expenditures. In particular, it comments on the effects of fiscal stress, tax limits, and state-imposed mandates. It then closely examines the use of tax increment financing (TIF) - a technique that is used by sub-state localities in all but one of the US states. After describing the steps in implementing a TIF district, the article examines the effects of its use, including its impact on redevelopment, new economic development, and on other jurisdictions. Fiscal stress Many American cities are still struggling with the effects of the latest economic recession, which lasted from December 2007 until June 2009 (Hoene and Pagano, 2010). The long downturn became a litmus test of the health of local budgets and revealed important structural and institutional settings in which city governments make revenue and expenditure decisions. A vast majority of American cities rely on property taxes, local sales taxes, user fees and, less often, on income taxes for their budget revenues. While income taxation is typically the federal and state prerogative in the US, some jurisdictions that do not enjoy a rich property or sales tax base use local income taxes as a revenue source. Added to the own-source revenues are intergovernmental transfers, which largely come to localities from states. Intergovernmental transfers are often earmarked for specific programmes, although some state aid goes directly into the General Fund. In 2008, state aid to local governments amounted to 30.5 per cent of total local revenues while federal aid was at the level of 3.8 per cent (calculated by authors from the US Census Bureau data). In 2009, the federal government implemented the American Recovery and Reinvestment Act (ARRA) and disbursed billions of dollars to local education programmes, transportation and construction projects. These programmes and projects would not have been undertaken or would not have withstood the economic recession in the absence of the federal support. The ARRA fund disbursement ended in 2011. The recession demonstrated that changes in economic conditions weaken all major sources of municipal own-source revenue. Usually, income elastic sources, such as sales tax and user fees and charges, are the first to reflect an economic recession. They generate smaller revenue collections as soon as the consumer confidence weakens and income growth stalls. The latest recession, for example, led to a free fall of sales tax revenue for months and resulted in sustained fiscal stress. Revenue from city sales taxes declined by 6.6 per cent from 2008 to 2009 and were forecasted to decline by an additional 4.9 per cent in 2010 (Hoene and Pagano, 2010). Property tax collections, a traditionally stable local revenue source, have also not been immune to the negative effects of the economic downturn. The American housing market crisis triggered a decline in property market values. The latter gradually led to a decline in property assessment values, which in turn affected property tax collections. The trickle-down effect of the housing market crisis may take from 18 months to 2 years before it is reflected in local budgets (Hoene and Pagano, 2010). Unlike sales tax and user fee collections, property tax revenues slowly bounce back to the pre-crisis level when the local economy fully recovers. Structural changes that have taken place in the housing market will not permit property values to rise to the pre-crisis level for many years. Insufficient property tax collections mean that local governments need to look for alternative sources of revenue or raise property tax rates or assessments to balance their budgets. Not many governments freely enjoy the latter option today. Some cities perform assessment valuations biannually and are hesitant, for political reasons, to raise property tax rates. …