Financing Community Redevelopment Through
Land Value Increments:
An Alternative to TIF
Dr. Thomas Gihring
[A paper presented at "Exploring Innovation: A Conference on
Community Development Finance, St. Louis, Missouri, 2-4 May, 2007.
Reprinted in
GroundSwell, May-June 2007]
Community Redevelopment Financing
Under tax increment financing law (TIF), a municipality is
authorized to issue bonds to finance the construction of public
facilities that are expected to precipitate new private investment
within “blighted” areas. This results in rising site and
building values, hence a higher property tax base. The tax revenue
collected from the increased property assessments within a
designated redevelopment district is used to pay off the bond debt.
The “increment value”, then, is the amount over and above
the “base value” — the fair market value determined
at the time a redevelopment district is established. The incremental
revenues are diverted from taxing jurisdictions for the duration of
the bond debt-servicing period. When the public improvements are
paid for, all subsequent property tax revenues revert to the taxing
jurisdictions.
Over the past three decades, TIF has become the primary local
financing tool for urban redevelopment, replacing the federally
funded urban renewal programs dating from 1949. State enabling laws
require local jurisdictions to provide evidence that private capital
investment in a blighted area would not reasonably be anticipated
without the adoption of a redevelopment plan, publicly assisted land
assembly, and supporting public improvements.
TIF Criticisms and Reform Efforts
Public interest organizations throughout the country are voicing
concerns about the use and benefits of tax increment financing. The
Community Development Network challenged the Portland Development
Commission over issues of involuntary displacement on the Interstate
Corridor Urban Renewal Area, Portland, Oregon’s largest TIF
district encompassing 3,700 acres. Some local organizing efforts are
aimed at limiting the destructive impacts of TIF on low-income
residents. Others, aimed at exposing abuses of TIF laws, charge
cities with using the tool to underwrite projects in affluent
suburbs, to subsidize construction on flood-prone land and exurban
greenfields, and to finance auto-dependent shopping centers and
sports venues. Indeed, the definition of “blighted” has
been gradually expanded beyond the traditional factors that include
structural dilapidation, obsolescence, abandonment, and sub-standard
habitability. Under pressure from business associations, many of the
47 states with TIF legislation include economic obsolescence as a
qualifying criterion.
Still others criticize the proliferation of TIF districts, many
of which are developer-driven and have as their primary purpose a
commercial rather than a community use. The City of St. Louis has as
many as 85 ongoing TIF projects; Chicago has almost as many. While
bonded indebtedness mounts and property tax revenues are diverted
from city services, the effective tax burden is shifted onto
residents who are often less able to carry the tax load than the
corporate owners who benefit at the city’s risk. Examples of
TIF projects that critics have targeted as abusive or excessive
include the St. Louis suburban jurisdictions of Webster Groves
(Lockwood Ave. business district), Des Peres (West County Center
shopping mall), Hazelwood (Missouri Bottoms industrial park), and
Olivette (a developer-proposed retail complex).
In response to mounting debt accumulating from ongoing multiple
TIF districts, some states have authorized the expansion of the tax
increment base to include economic activity taxes such as the sales
and earnings tax. Criticism against this approach stems from the
observation that unlike the property tax base, the EAT base does not
actually expand with new development; rather, sales-generating
outlets in TIF districts are likely to have moved from non-TIF areas
or captured sales volume from outlets in other locations. The
taxation of retail sales transactions also carries with it a
troubling set of incentives. Experience shows that local
redevelopment agencies often seek out project areas with the
greatest potential to generate tax revenue, even if the areas are
not blighted or depressed. If the tax base consisted of sales
receipts, then local officials would lean towards income-producing
projects — most likely commercial ventures rather than
community revitalization.
Voices for TIF reform are beginning to be heard in statehouses
throughout the country. The major reform efforts have focused on:
(i) tightening the definition of “blight”, (ii)
restricting the use of TIF for retail development, (iii) prohibiting
the delineation of TIF districts on greenfields or sensitive land,
(iv) excluding sales tax revenue from tax increments, (v) limiting
the size and number of TIF districts. Recent TIF reform bills
introduced in the Missouri legislature attempt to address some of
these issues, as well as the problem of negative fiscal impacts on
school districts.
Evaluation of Conventional Taxation Methods
The use of the conventional property tax to capture tax
increments sets up a system of adverse incentives. Generally,
building value constitutes the bulk of real property assessments. By
imposing heavy tax burdens upon substantially improved properties,
the property tax discourages new investment in targeted areas. When
designating a TIF district in a neighborhood where private
invest-ment has remained stagnant, a local jurisdiction commits to
sizable investments in public infrastructure and facilities. This
results in the rise of market value of land sites, regardless of
ownership or use. The intent to precipitate development is thwarted
when owner/developers are faced with substantially higher tax
burdens for investing in new buildings. Responding to this adverse
incentive, property owners may well find it more lucrative to hold
onto vacant or underutilized sites for later resale, rather than to
undertake timely improvements. Hence, the conventional tax system
amounts to an inducement to speculate on sites and capture the
windfall gain. A more progressive tax increment financing mechanism
would capture the “economic rent”, or the surplus payment
deriving from a site’s locational advantage, public
improvements, and synergistic spillovers from general growth and
development.
Value Capture Financing
Clearly, there is a need for a tool as powerful as tax increment
financing, yet with safeguards that prevent undesirable outcomes. A
legal financing structure is needed to ensure that urban growth
management objectives, including compact urban centers and
affordable housing, are met. It should include built-in incentives
for developers to construct in accordance with pre-adopted
comprehensive plans, and include disincentives to speculate on sites
intended for redevelopment.
Principles
Public sector commitments, in the form of approved detailed
plans, up-zoning, and capital funding, will stimulate private sector
investments in commercial space and housing. Together, these public
and private investments will result in the growth of economic rent.
Site value increases are experienced generally, that is, independent
of capital investments in building improvements that individual
property owners may undertake. Owners and purchasers make investment
decisions based upon local government performance. Thus, public
sector actions coincidentally give property added value, frequently
labeled “betterment”.
This surplus value, reflected in land value assessments, can
either be retained by individual owners as capitalized assets, or
captured by the public sector to be distributed through revenue
expenditures in the form of public bene-fits. A basic principle in
liberal economic theory holds that legitimately created value
belongs to the creator of that value. Hence, government in its role
as the steward of publicly created value is justified in collecting
what the community has given. Public juris-dictions have the
legitimate right to recapture land values, either through property
taxes, or developer exactions requiring direct contribu-tions to a
prescribed public purpose such as the provision of below market-rate
housing. On the other hand, improvement value, the remaining
(usually larger) component of property assessments, is attributable
to private capital investment in individual parcels. Owners have the
legitimate right to retain the building value that they themselves
have created.
The appropriation of land value can be accomplished on a broad
scale through the general property tax by converting the system to a
land value tax (LVT) -- based either entirely on land assessments,
or mostly on land assessments (accomplished by a split rate).
Alternatively, it can be applied to specific tax benefit districts.
In the case of TIF, this ‘surplus’ increment can be used
-- at the front end -- to help finance the public improvements
needed to induce desired private building investments. The key is to
collect tax increments through value capture rather than through the
conventional property tax, which because of the burden on building
value, reduces the incentive for new private investment where it is
most needed.
The capture of incremental land value produces two socially
desirable effects: (1) It reduces the temptation for land owners to
speculate on sites by keeping them out of productive use, and (2) It
raises land holding costs to a level at which owners will seek a
better return on their property investment by making building
improvements. Legislators should resist the temptation to augment
tax increment receipts by taxing improvement values as well as land
values. This would only slow the redevelopment process and extend
the bond indebtedness period.
Application
The principle of value capture is relatively easy to put into
practice due to the fact that taxable benefits are closely tied to
true value land assessments. As with any TIF legislation, cautionary
measures must be taken so that the capital costs of public
improve-ments to be recovered through tax increments do not exceed
the cumulative increase in land values expected to occur over a
reasonable cost recovery period. In preparing plans for a TIF
district, a redevelopment agency would first estimate the total
redevelopment capacity of undeveloped and underdeveloped sites
within the proposed district. An estimated improvement value is
placed on the projected new redevelopment, and the expected land
value growth within the district is projected. In the case of value
capture, taxable assessments are based primarily on total annual
land value. This coincides with land rent, or annual “unearned”
capitalized gain that all property owners within a limited sized
district would experience. Here is where the major distinction is
drawn between value capture and conventional tax increment
financing, which collects land and improvement values. In order to
achieve revenue neutrality (in the base year), the land tax rate is
set to the mill rate that captures an amount equal to the
conventional property tax.
Tax allocation bonds in the amount of projected land value tax
increments are issued at the time construction of public
improvements commences. The term “geo-bond” might be used
to distin-guish the capture of land rent as a bond financing
mechanism from other taxing mechanisms that include the building
component of assessed value. In practice, no urban jurisdiction in
the U.S. adopting the land value tax method has entirely eliminated
the building tax; rather, split rates are used whereby the larger
portion of the combined tax rate applies to land assessments.
Illustration
The City of Seattle identified several “urban centers”
in its 1994 comprehensive plan. By 2000, all 38 detailed
neighborhood plans were approved by City Council and are currently
the focus of departmental and citizen efforts to find the
appropriate means of implemen-tation. The proposed Brooklyn Center,
a key element of the University Community Urban Center plan offers a
case study of how value capture might be utilized to fund planned
public improve-ments in a “CRF” district. (In Washington
State, the nomenclature is Community Revitalization Financing.)
Planned major redevelopment activity converges on an 8-block area
consisting of 89 parcels. Predominant uses currently consist of
auto-related commercial establishments including expanses of surface
parking. The plan envisions a high density, mixed-use residential
community. A small area is chosen for this case study so as to
enhance the leverage effect of public improvements on site values.
In order to stimulate new private investments in a local area, the
public impact needs to be concentrated and highly visible.
Stages in this case study include: (1) estimates of land
redevelopment potential and new development capacity; (2) a
simulation model capable of projecting the incidence of rebuilds on
underdeveloped parcels, and estimating the growth of land and
building assessments over a redevelopment period; (3) hypothetical
tax applications on aggregated parcels, comparing revenue outcomes
from both conventional and land value taxation systems; (4)
calculation of tax increments available for urban renewal bonds; (5)
an estimate of financial incentive, measured by the shift of tax
burdens off of building assessments.
The 1996 assessed value of land and improvements in Brooklyn
Center is $54.6 million. Land value as a proportion of total value
in the core area is 57%, compared to 42% for the city as a whole,
meaning that building value comprises only 43% of the total
assessment base. This high land-to-total value (LTV) ratio is one
prime indicator of under-invest-ment. A second indicator is a
standard measure of site utilization. The floor area ratio (FAR) is
the internal floor area of buildings divided by lot area. The
aggregate FAR is 0.76 -- less than a one-story building. The
potential for redevelopment in the target area can be estimated by
establishing thresholds for both of these valuation and site
utilization ratios. In this case study, those parcels on which the
LTV ratio is higher than .66 and the FAR is less than 0.75, fall
into the category of “underutilized”.
Within the 19.6-acre district, 48 parcels meet both threshold
criteria for vacant or underutilized. Exceeding both thresholds on a
given parcel precipitates a rebuild, or new construction. Inserting
a target LTV ratio of .32, which is the ratio of land-to-total
assessment that is the norm for recently developed areas, optimizes
the redevelopment simulation model. This means that over an extended
period, land values will increase in the redevelopment district at
an average annual rate of about 11.5 percent as new building
activity takes place. As land values rise, additional parcels exceed
the threshold levels, thus precipitating more rebuilds. The model
projects 64 rebuilds within a period of 17 years.
In accord with rezoning plans for Brooklyn Center, building
capacity averages out at a density of 2.5 FAR. If these 64
redevelopable parcels were fully developed at the capacity FAR, the
total projected floor space would amount to 1.5 million square feet.
Using an estimate of typical building assessments for new mixed-use
mid-rise construction proposed in the UCUC plan, a total of $234
million in added building value is projected within the area. Adding
this volume and value of new construction means that total building
values (including existing fully-developed parcels) would grow at an
average rate of 19 percent annually. Assuming an even rate of
rebuilds, a longitudinal array of 17 annual land and building
assessments is derived for use in the simulated property tax
applications.
For purposes of this case study, Brooklyn Center is designated as
a Community Revitalization District (CRF). All the normal methods of
tax increment financing are implemented here with the exception of
the differential property tax rates that are applied to land and
building assessments. The aim is to capture land value increments
rather than growth in building values. The “land value tax rate
ratio” is set at 90%, meaning that 90 percent of the combined
tax rate is applied to land assessments.
Following recommended practice when converting to an LVT system,
a split rate in the base year produces the same revenue as the
conventional single-rate tax. The question of where revenue
neutrality is established is critical to implementing LVT, as the
resulting tax shift across properties is significantly affected.
Under a 2-rate system, the breakpoint – determined by the
overall LTV ratio in the taxing jurisdiction wherein
revenue-neutrality is established -- locates the fulcrum from which
upward or downward tax shift occurs. In essence, the tax shift
experienced by any single parcel depends upon its own LTV ratio
relative to the aggregated LTV ratio of all other properties within
the jurisdiction.
Tax shift outcomes are “normalized” when the total land
and building assessments used to establish revenue neutral tax rates
are taken from a larger jurisdiction such as the county or city. A
case in point: The overall LTV ratio of assessments in King County
(and the City of Seattle as well) is .42. Individual parcels having
a higher ratio than .42 will experience a positive tax shift;
parcels having a lower ratio will experience a negative shift. If
the 8-block CRF district were the locus of revenue neutrality, the
overall assessment ratio of 57% would locate the fulcrum in a
different position. Thus, some parcels in the district, which at the
county level would experience a positive shift, would instead
experience a negative shift. Because of the predominance of
underutilized sites, the district is not representative of the
metropolitan region as a whole; therefore establishing split rates
at the district level would distort the incentive effects of the
LVT.
The previously derived array of 89 annual land and building
assessments is associated with a set of split rates derived from
aggregate county assessments that are projected to grow at the
historic trend rate of about 6% annually. A conventional rate of
$12.50 per $1000 AV is the total tax rate for the Seattle Levy Code
area, and is used as the base year rate. The split rates derived for
the levy code area are proportional to the split rates derived at
the county level. For over a decade, property taxes in Washington
State have been subject to statutory limitations; hence, a 6% annual
revenue growth limit is applied to the algebraic formula used to
obtain split rates.
At the base year, the conventional property tax on the 89 parcels
in the CRF district yields $682,406 in revenue. The split rates of
$24.63 applied to land assessments and $2.74 applied to building
assessments yields $835,922. The difference in base-year yields is
due to the large number of underutilized properties in the district.
Because the LTV ratios on these sites are high and tax burden is
shifted onto land values, the tax yield is higher. This phenomenon
occurs in the early years of the tax increment financing period; but
as construction activity increases, the LTV ratios gradually
decrease, yielding comparatively smaller revenues in the later
years.
The base year revenue from the land value tax is subtracted from
each subsequent year’s tax revenue to produce an annual tax
increment used to finance bonds for public improvements in the
district. The bond period includes Year 2 through Year 16.
Cumulative tax increments over the 15-year period amount to $22.5
million. This is about $4 million less than the amount that a
conventional tax would yield, but unlike the single-rate tax, the
LVT does not depend upon the accumulating building values in the
district. Total assessed value in Brooklyn Center grows to a
projected $581.7 million by the 17th year. The cumulative increments
will finance an estimated $18.7 million in bonding capacity. The
total $234.2 million of added building value generates a 12.5:1
ratio of private-to-public investment.
Finally, the incentive effects of the LVT expressed in terms of
tax shift are examined. Over the 15-year tax increment financing
period, a conventional tax would capture $21.8 million in taxes on
buildings compared to only $4.8 million from a 90% LVT. This amounts
to a cumulative savings of $17 million for property owners investing
in redevelopment. On the other hand, a total tax burden of $15.5
million is shifted onto land values, especially in the beginning
years when properties are largely underutilized.
Observations
The important feature of the value capture method applied to TIF
is that cumulative taxable building value, in this case totaling
$234 million, is barely taxed. This incentive to redevelop sites is
enhanced by lifting a $17 million cumulative tax burden off of
building owners.
Because the scheduled public improvements are concentrated in a
small 8-block area, the impact on land values in the area is clearly
visible; all properties will be uniformly and strongly affected.
Moreover, because the $54.6 million first-year district assessment
is only 0.13% of the city-wide assessment, the city’s taxing
districts are not heavily impacted by the diversion of base-year
revenues.
Value capture as an alternative tool to the conventional property
tax should be able to discourage land speculation within taxing
districts and place community-generated value where it justly
belongs -- in the public realm. There is no reason to limit the
value capture method to redevelopment districts. Reforms of property
tax legislation at the state level could authorize the use of LVT by
counties and cities as well.
***
Tom Gihring is an international planning consultant
based in Seattle. He previously taught graduate urban planning, and
has undertaken several studies in land value taxation and value
capture He may be emailed at tagplan@comcast.net
