Should Australia Embrace Tax Increment Financing?

Thursday, November 26th, 2015
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Toward the latter part of the last century, the City of Chicago and State of Illinois faced a common US problem in terms of a drying up of federal and state funding for important economic development projects.

Rather than shrink priorities to fit around a lower funding pool, however, they decided instead to leverage what is commonly known as a tax uplift. Tax uplift occurs as the increased amenity associated with the works concerned helps to attract residents and/or commercial operations to surrounding areas. This helps to drive property values (and thus future municipal tax receipts) throughout the surrounding area higher than would otherwise have been the case in absence of the works.

Under this program, up-front cash to help finance projects was raised in one of two ways. The first involved the issuance of municipal type bonds which were supported by additional revenues associated with the uplift which results from the particular project in question. Second – and more commonly, in Chicago’s case – up-front funds for approved projects would be put up by developers rather than the Council, with the City reimbursing the developer over time out of revenues associated with the aforementioned tax increment stream.

As of 2008, the City was supporting or had supported economic projects across 130 specific districts comprising more than 29 per cent of its total area in this way.

In the late 1990s, for example, around $7 million out of a total project cost of $7.7 million was raised in this way for a makeover of the theatre district, which included vintage style streetlights with space for banners that announce the latest theatre shows, old-fashioned kiosks with maps indicating theatre locations, newly planted trees, sidewalk planters and new sidewalk treatments which included granite and slate theatre district logos set into the pavement.

Around the same time, a similar method was used to raise part of the money to transform what had previously been a polluted and in some parts inaccessible Chicago River area into a public space with pedestrian and bicycle paths, parks, restaurants, and docks for boaters.

Chicago is not the only city to embrace tax incremental financing (TIF). Originating in the 1950s in California, TIF is now used across most US states (as well as in the UK for the past decade) to fund repairs, upgrades and improvements to water and wastewater infrastructure, parks, curbs and sidewalks, roads, street lighting, landscaping, the local environment, emergency service facilities, and community centres.

Unlike the situation in Chicago, this most commonly works through the sponsoring government issuing bonds to provide the funds necessary for large upfront and urban renewal projects. Over time, as these works improve, the liveability of the relevant TIF district results in more property development in the area. Property values (and hence amounts received from property taxes) rise, and a specified portion of this increment is allocated to a special account from which the debt is serviced.

Now it appears the concept could be about to arrive in Australia. Last month, Fairfax Media reported that senior government sources were enthusiastic about the concept and that the idea was given serious thought as a means to help the local Gold Coast City Council raise the $120 million it needed to fund its share of the first stage of the Gold Coast Light Rail project.

While acknowledging that TIF is not a silver bullet and does not in itself represent a comprehensive solution for Australia’s urban renewal funding challenges, Property Council of Australia CEO Ken Morrison says its potential to form part of the solution to Australia’s urban renewal funding challenges should not be understated.

Morrison says the concept is unlikely to be suitable to fund massive projects such as rail lines which run right across metropolitan areas, but could easily be used to fund smaller types of infrastructure such as train station upgrades.

“We think this financing is not the only solution but certainly an additional solution that should be added within Australia,” he said.

Morrison says a critical advantage of TIF revolves around the fact that it effectively captures part of the value uplift which results from the works but does so in such a way that does not represent a new form of tax or an increase in rates of existing taxes. It merely takes advantage of additional tax revenues which occur naturally because properties within designated areas within the vicinity of the upgraded works are worth more than they otherwise would have been had the infrastructure not been in place.

By contrast, some other value capture methods (such as extra sales tax within a given catchment area, for example), involve the imposition of new or higher rates of taxes or charges and can inadvertently serve to discourage the very investment which would help generate the growth outcomes which the works in question were trying to deliver, he said.

“A lot of people propose new taxes around growth areas in various ways (as value capture methods),” he said. “Well, if you tax something more, you will generally get less of it. It doesn’t make a lot of sense if you want to actually encourage growth in a particular area to tax it.

“On the flip side, if you are going to put infrastructure in well, you have got to make sure that that infrastructure is being fully utilised as early as possible. We do want to make sure that as our cities grow, they grow around the new infrastructure that is being put in place. This (tax increment financing) is a way of ensuring that infrastructure providers are aligned with the planners who are looking at the growth outcomes.”

Still, not all are enthusiastic about the idea. In the US, a report published in 2011 by advocacy group U.S. PIRG Education Fund acknowledged that TIF can promote growth and stronger communities when used properly and sparingly. The group argued, however, that the process through which TIF takes place often lacks transparency and accountability, and in some cases has the potential to be used to create ‘slush funds’ or be used to channel money into politically favoured special interests. That report called for an overhaul of rules to ensure TIF districts were suitably targeted, subsidy recipients were held accountable for meeting goals and information was transparent.

Moreover, Morrison says there are a number of things need to be done before TIF is ready to be used in Australia, including the passing of legislation to allow such instruments to be used and getting state governments on board.

He says the concept should initially be introduced on pilot programs, such as an urban renewal project currently taking place in Newcastle.

As governments increasingly become strapped for cash, innovative funding mechanisms for urban renewal projects will become increasingly important.

Based on current sentiments, it is likely that tax increment financing will be part of the mix.

How Tax Increment Financing Works

According to a PwC report prepared for the Property Council in 2008, tax increment financing in the US typically works as follows:

  1. A TIF program usually begins when a municipality (the sponsoring jurisdiction), designates a geographic area as a TIF district. Traditionally, the sponsoring jurisdiction is the municipality, the district encompasses an area that is blighted or in need of revitalisation and infrastructure upgrade and the sponsor’s intent is to demonstrate a public commitment to the viability of an area and thereby encourage complementary private sector investment.
  2. To qualify for TIF, the area and infrastructure must meet certain requirements – typically detailed in TIF enabling legislation and supporting regulations and guidelines. In general terms, these requirements are aimed at ensuring TIF-funded infrastructure and urban development or redevelopment deliver genuine benefits to the TIF district and broader community. They might require, for example, the sponsoring jurisdiction to demonstrate the need for and benefits of TIF intervention.
  3. In the TIF district, a tax ‘base’ is established. This is usually the existing property tax base ‘frozen’ at pre-TIF levels. Alternatively, it could be this tax base indexed by some factor (such as the rate of inflation) over time. The revenue from this tax base is apportioned to all taxing authorities in the standard way.
  4. The TIF becomes operational when the sponsor borrows funds (usually via issuing bonds) and undertakes investments in eligible infrastructure and development in the TIF district. This investment and infrastructure delivery can involve varying levels of public and private partnership arrangements, and can apply to a range of development and infrastructure.
  5. As time goes on, this investment leads to higher levels of economic activity and property appreciation, which in turn leads to growth in the district’s tax revenue. The difference between the tax revenue and the tax base in each future year is called the incremental value, and a proportion of this increment is assigned to a special account of the sponsoring jurisdiction to service its TIF debt (usually TIF bonds).
  6. When the debt is retired, the TIF ceases to exist.
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