Tax Subsidies to New and Old Urbanists

The subsidies mentioned in yesterday’s post about Denver were in the form of tax-increment financing (TIF). For those unfamiliar with the term, tax-increment financing is the principal method of funding urban renewal. An urban-renewal agency draws a line around an area to be renewed, and for the next twenty or so years all property taxes collected on any new improvements in that district — the “incremental” taxes — are used to subsidize the renewal program.

Usually, the agency estimates future tax revenues and then sells bonds to be repaid by those revenues. The bond revenues might be used for infrastructure such as streets, improvements such as parking garages and parks, or they might simply be given to the developer as seed money for the project.

There are all sorts of variations. In Colorado, a property-improvement fee (PIF) is a sales-tax version of TIF: some or all sales taxes from a retail development are diverted to subsidize the development. Some states use EAT, which allows new businesses to avoid sales, income, and other economic activity taxes. Texas has tax-increment reinvestment zones in which developers are simply rebated the property taxes paid on the new development.

Some planners are arrogant, or ignorant, enough to claim that TIF is not a subsidy because the development pays for itself. Yes, and if I got to keep twenty years’ worth of property taxes on my home, I could build a bigger house and claim it paid for itself. But someone else would have to pay for the sewer, fire, police, schools, and other services that my family uses. Make no mistake about it: TIF is a subsidy.

Like so many other questionable ideas, TIF originated in California in the 1950s. Today, every state but Arizona allows cities to use TIF. Go to Google news and search for tax increment and you will find TIF controversies all over the country.

• In Kansas City, a study by a university economist found that, far from curing blight, TIFs there were mainly used to subsidize development in affluent areas.
• Aberdeen South Dakota voters have demanded the right to approve a TIF subsidy being offered to a meat-packing plant. The argument for the TIF is not that the area is blighted but that Aberdeen has to offer subsidies to compete with other cities that want to subsidize a new plant.
• The school district in a St. Louis suburb is opposing TIF subsidies for a new residential area because the development “would put more children in district schools without a corresponding increase in tax revenues.”

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In many, if not all, of these cases, the reason for the TIF is not that the neighborhood in question is blighted but that the city wants to see some new development that may eventually add tax revenues to its coffers. In some cases, the city would collect sales taxes on retail, thus covering its costs, while schools, fire, and other programs that rely on property taxes would suffer.

Many of the opinion columns I read about TIF say something like, “When properly used, TIFs can do good things.” Then they go on to say that a particular TIF that they find objectionable is not proper. Perhaps they don’t want to see TIF money going to Wal-Mart but wouldn’t mind TIF being used to attract a Trader Joes. Or perhaps they want TIF to redevelop someone else’s neighborhood but not their own. Often they debate about whether a particular area is really “blighted.”

But the problem with TIF is not that it is sometimes abused but that it is an open invitation for abuse. Even if you believe that government can and should do something about blighted areas, you cannot define blight narrowly enough to prevent government agencies from defining just about anything they want as blighted. In one famous case, San Jose declared a neighborhood blighted partly because the homeowners, one of whom was the local U.S. representative in Congress, failed to rake the leaves in their backyard tennis courts.

When you give cities the power to divert taxes from their usual recipients and into special slush funds for developers, you create a whole cascading series of moral hazards.

• The redevelopment agencies that manage TIF have little incentive to consider the impact on other programs. Screw the schools! We need TIF to enhance our budgets and justify our existence.
• Instead of simply curing blight, urban planners are tempted to use TIF to subsidize their visions of New Urbanism or whatever. Hey, we don’t have to worry about market feasibility anymore — we’ll just use TIF to bribe developers into building what we want.
• Corporations seeking to locate facilities being to shop for TIFs and other subsidies. If every city offers such subsidies, then the corporations simply locate where they want, and the taxpayers lose.
• Once local developers get a taste of TIF, they lose interest in doing any developments that are not subsidized. Why build an unsubsidized shopping mall or residential area that has to compete against others that are subsidized?

As one Kansas City mayoral candidate observed, cities and developers get addicted to TIF the same way that medical patients get addicted to painkilling drugs. “In economic development, we’ve come to completely rely on drugs,” he noted.

Moreover, there is growing evidence that TIF actually reduces long-run economic development and, in turn, tax revenues. One recent study found “evidence that cities that adopt TIF grow more slowly than those that do not.”

This could happen because, to the extent that TIF-subsidized projects compete against other businesses, they may harm those businesses and reduce the incentive for them to expand. As a recent study of TIF in New Orleans observes, “To the extent that other areas and businesses are negatively impacted, the existing revenue base of the local government is reduced.” For this reason, says the study, “it is exceedingly dangerous to view TIF as free money.”

Judged against all of these problems, the potential benefits of using TIF to recover blighted areas seem miniscule. Frankly, I don’t believe subsidies are needed to recover blighted areas. We’ve seen enough gentrification without subsidies to know that urban areas are dynamic and any blight is only temporary.

TIF often goes hand-in-hand with eminent domain, which is much more controversial partly because it is so much easier to understand. In most states, when an urban-renewal agency declares a neighborhood blighted, it can use eminent domain to force the sale of properties in the neighborhood. When it buys such properties, it probably uses TIF to finance the purchases.

Since the Supreme Court decision on Kelo v. New London, at least thirty states have passed laws restricting the use of eminent domain. But if we really want to stop urban-renewal abuses, we also need to repeal TIF laws.