October 2, 2003

Tax increment financing: why it isn’t working here

  • Other states use TIF to help blighted neighborhoods
    Foster Pepper & Shefelman


    Whether its broken or dead, tax increment financing isn’t working yet in Washington state.

    Tax increment financing, TIF, is used widely in other western states to finance public infrastructure and spur economic development and redevelopment of blighted neighborhoods. Our state constitution and property tax statutes do not allow for the wide-open TIF used in California, Oregon, Idaho and Nevada. Some say this puts our communities at a disadvantage when competing in “beauty contests” to lure development to Washington.

    Tax increment financing is a property tax allocation mechanism. In neighboring states, TIF is usually run by urban renewal and redevelopment agencies. These agencies designate blighted areas as urban renewal or “increment” areas, with an eye toward businesses interested in locating or expanding their operations in the areas.

    Property values are expected to increase within the increment areas as land is developed and redeveloped. TIF harnesses the resulting increase in property tax revenue from the increment area. This revenue is used to repay bonds that finance public improvements in the area.

    The key to TIF in most states is that the urban renewal agency receives revenue from all property taxes collected within the increment area, regardless of the entity levying the tax or the type of tax levied. TIF typically traps a portion of every property tax dollar generated in the increment area. This is the magic of TIF. As an increment area matures, a substantial amount of tax revenue can be diverted to the urban renewal agency.

    Washington state has been denied this magic. Voters rejected attempts in 1973, 1982 and 1985 to amend the constitution to authorize the type of TIF that other states use. In the mid-1990s, the city of Spokane tried to implement a TIF project. This set up a case in which the state Supreme Court ruled the state’s TIF statute was unconstitutional. The Legislature has considered TIF bills in most sessions since that defeat.

    The state’s latest TIF statute was enacted in 2001. It authorizes cities, counties and port districts to use TIF. Many hoped this statute would spawn numerous projects.

    To date, only one “increment area” has been created under the new law. Why? There are several reasons.

    Reason 1

    TIF works best if property taxes are levied solely on the basis of mill rates (i.e., specified dollar amounts per each $1,000 assessed value) and if the TIF statute traps a portion of each property tax dollar collected within the increment area.

    Without a constitutional amendment and radical changes to our property tax statutes, neither of these conditions can be characteristic of TIF in Washington. Our statutes generally require that property taxes be levied in specific dollar amounts. They generally cap annual tax increases to 1 percent of the prior year’s levy, with an exception for taxes based on the value of new construction. The potential for substantial growth in tax increment revenues is limited.

    Reason 2

    TIF fails to produce enough revenue to fund meaningful infrastructure improvements. The state constitution precludes the use of property tax — or at least that portion of the tax levied to support schools — for TIF purposes. It probably precludes the use of other voter-approved property taxes (e.g., school levies and bond levies) as well.

    The state’s TIF statute was drafted to address these constraints. The result, however, is a TIF mechanism that applies to a small portion of the property tax revenues. Under the best circumstances, the assessed value of taxable property within an increment area must increase by about $18 million to support each $1 million of TIF bonds.

    Significant increases in assessed value of property must occur in the increment area before tax increment revenues will be sufficient to finance meaningful improvements. This tends to limit TIF’s effectiveness to projects that involve undeveloped and under-developed property.

    Reason 3

    Washington law requires the government using TIF to enter into agreements with the local governments whose tax revenues will be diverted. Think about the consequences of that requirement. Only the most compelling projects will survive — i.e., those that appeal to the majority of the governing body of each local taxing authority. This also subjects TIF to the vagaries of local politics.

    It may be very difficult to implement TIF in those communities where the local governments lack good relations.

    Reason 4

    In contrast to other states, Washington’s statutes provide that TIF bonds will constitute general indebtedness. This means the par amount of such bonds will count against debt limitations applicable to the entity issuing the bonds. It also suggests that the issuer’s general fund may be at risk to repay the bonds. For obvious reasons, most local governments hesitate in using their debt capacity and risking their general fund.

    Reason 5

    The type of public improvements that can be funded through TIF is limited. More improvements can be funded through the state’s existing local improvement district laws.

    Reason 6

    The Washington TIF statutes do not provide the flexibility to address future infrastructure needs in an increment area. TIF revenue only can be used to finance improvements that are identified at the time the increment area is created. Over time, surplus tax increment revenues may accrue, but the local government cannot use this revenue to finance new projects unless it listed the projects in the initial ordinance creating the increment area.

    TIF has a place in our economic development tool chest. However, it may be merely a three-penny nail, rather than the powerful hammer many had desired.

    Attorney Jeff Nave is a member and chair of the Municipal and Public Finance Practice Group at Foster Pepper & Shefelman PLLC. He practices in the firm’s Spokane office with an emphasis on public finance and federal tax law.

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