An Elected Official's Guide to Tax Increment Financing

An

Elected

Official’s

Guide to

TAX INCREMENT FINANCING

Nicholas Greifer

Government Finance Officers Association

Copyright 2005 by theGovernment Finance Officers Association

of the United States and Canada203 N. LaSalle Street, Suite 2700Chicago, Illinois 60601-1210www.gfoa.org

All rights reserved.

The text of this publication, or any part, may not bereproduced without written permission from the pub-lisher.

Library of Congress Control Number: 2005925700

ISBN 0-89125-272-X

Printed in the United States of America

First printing, May 2005Second printing, July 2007

CONTENTS

v Foreword

1 Introduction

3 Section I:FUNDAMENTALS

What is tax increment financing?Why do governments use tax increment

financing?What are the different types of TIF

districts?Where is tax increment financing used?Can local governments other than

municipalities establish TIF districts?What type of projects is tax increment

financing used for?Why has the use of tax increment

financing become more widespread?How does tax increment financing differ

from other economic developmentfinancing tools?

12 Section II:TIF MECHANICS

What is the general process forestablishing a TIF district?

What criteria are used to establish a TIFdistrict?

What is the but for requirement, and howis it defined?

How long are TIF districts in operation?Who comprises the TIF management team?How large should a TIF district be?How is stakeholder participation

incorporated into the TIF process?

23 Section III:EVALUATING TIFS

What are the general advantages of taxincrement financing?

What are the disadvantages of taxincrement financing?

Why is tax increment financingcontroversial?

How are TIF projects assessed andmonitored?

How effective is tax increment financingas an economic development tool?

iii

33 Section IV:FINANCING TIF DISTRICTS

How are TIF expenditures financed?What is a feasibility analysis and

proforma?What factors determine whether a TIF

revenue projection is accurate?What happens to TIF surplus funds?What types of TIF-related bonds do

governments issue?How are TIF bond proceeds invested?What criteria do rating agencies use to

evaluate tax increment bonds?What risks do bondholders face in buying

TIF bonds?What can governments do to obtain a

better credit rating?Is there an ideal debt coverage ratio for

bonds supported by incrementalrevenues?

What documents do rating agencies needto evaluate tax increment bonds?

Will insurance companies provide creditenhancement for tax increment bonds?

What are the benefits of a financial policygoverning tax increment financing?

How does a government protect itsfinancial position vis-à-vis a developer?

58 GFOA RECOMMENDED PRACTICEEconomic Development Incentives (1990)

59 APPENDIXProfiles of TIF DistrictsResources

iv

Foreword

Each year state and local governments invest ineconomic development strategies to promotegrowth in their local economies. These strategiesfocus on job creation, increased economic activ-ity, and ultimately a broader economic base thatcan support needed government services. Whilethese are enduring goals, over the past two de-cades the preeminent tool for achieving economicgoals has been tax increment financing (TIF).TIF is widely used by municipalities across theUnited States, permissible in forty-nine states.

As TIF use has grown, so too has the need for in-formation on creating and managing TIF dis-tricts. An Elected Official’s Guide to TaxIncrement Financing is intended to provide clear,concise answers to commonly asked questionsabout TIFs. The guide is designed to provideelected officials with basic information on theconcepts and mechanics of TIFs as well as to de-scribe successful financial management practicesthat have been used to implement TIF projects.

The Government Finance Officers Association(GFOA) wishes to thank Nick Greifer of theGFOA Research & Consulting Center for devel-oping the publication. GFOA recognizes the fol-lowing members of the GFOA Committee onEconomic Development and Capital Planningwho contributed information about their tax in-crement financing experiences: Committee ChairPatricia A. Phillips, Director of Finance, City ofVirginia Beach, Virginia; Vice-Chair William A.Stafford, Finance Director, City of Evanston, Illi-nois; Michael J. Daun, Director of Financial Ser-vices, City of Milwaukee Comptroller’s Office,Wisconsin; and Catherine R. O’Connor, AssistantCity Manager/Finance Director, City ofOklahoma City, Oklahoma. Additionally, I thankTom Gavin, R.W. Baird & Company; Peter Ra-

v

phael, William Blair & Company; PatriciaCurtner, Chapman and Cutler; Charles Finch,Principal, Grant Thornton, LLC; GFOA Execu-tive Board Member Stan Helgerson, Village ofCarol Stream, Illinois; Joseph O’Keefe andAdrienne Booker, Fitch Ratings; Bob Rychlicki,Kane McKenna; John Peterson, Legg Mason;Leslie Murphy, LGM Consulting; and PattyTigue and Cheryl Twete of the City of Portland,Oregon.

Jeffrey L. EsserExecutive DirectorGovernment Finance Officers Association

vi

INTRODUCTION

Local economic development is a big business.Municipalities collectively spend billions of dol-lars for subsidies to encourage existing busi-nesses to stay or new businesses to move in.They employ myriad techniques to accomplishthis: building or replacing municipal infrastruc-ture, reducing regulatory burdens, and providingtax incentives.

The Government Finance Officers Association(GFOA) has a long-standing interest in promot-ing sound financial management when pursuingmunicipal economic development. In 1990,GFOA issued a recommended practice concern-ing the use of economic development incentives(reproduced on page 58). A key element of therecommendation was the practice of establishingcriteria to measure progress toward goals, andidentifying remedial steps when goals are not be-ing met.

This publication was written to familiarizeelected officials with one of the most populartools for local economic development, tax incre-ment financing (TIF). Although much has beenwritten about the pluses and minuses of usingthis financing method, less has been writtenabout the practical steps that can be taken toprudently use and manage TIFs. The objective ofthis book is to lay out the steps for using TIF aswell as identify and describe important financialmanagement concepts integral to TIFs. A sec-ondary goal is to help elected officials becomeconversant in TIF techniques, so as to betteroversee the staff that administer TIF districts ona day-to-day basis.

The guide is organized into four sections. SectionI introduces the fundamental concepts behindtax increment financing and the historical rea-

1

sons for its growing use among city and countygovernments. Section II provides background onthe mechanics and process of establishing andoperating a TIF district. Section III discusses theimpacts associated with tax increment financing,both positive and negative. Section IV discussesspecific financing techniques used to fund TIFprojects, including pay-as-you-go and bond issu-ance. Following the previously mentioned GFOArecommended practice, an appendix presentsprofiles of TIF districts in operation and a re-source list.

2 A N E L E C T E D O F F I C I A L ’ S G U I D E

Section IFUNDAMENTALS

What is tax increment financing?

Tax increment financing is a financial tool widelyused by local governments to promote economicdevelopment and redevelopment. The TIF pro-cess splits tax revenue generated from propertieswithin the TIF district into two components:

• Base revenues – This is the amount availablebefore the TIF district is established; base rev-enues are shared among a mix of local govern-ments that have the power to assess propertytaxes: schools, cities, counties, and specialdistricts.

• Incremental revenues – These new revenues inexcess of the base revenues are generated bydevelopment projects. Represented by the tri-angular area in Exhibit 1, these dollars are al-located to the government that sponsors theTIF project. Although some states permitcounties to use tax increment financing, inmost cases the sponsoring government is amunicipality.

Exhibit 1 • Assessed Value of Prototypical TIFDistrict

T O T A X I N C R E M E N T F I N A N C I N G 3

By giving exclusive use of incremental revenuesto the sponsoring government, the successful taxincrement financing process generates a revenuestream to underwrite projects within the TIF dis-trict and to provide development subsidies to en-courage growth.


Why do governments use taxincrement financing?

Governments employ tax increment financing topromote economic development and redevelop-ment. By capturing future incremental revenue,the sponsoring government is able to undertakeeconomic development activities or provide sub-sidies that otherwise might not be possible.

Historically, tax increment financing has beenviewed as a way to combat blight or deteriora-tion within city districts or neighborhoods. As itsuse spread to more states, however, tax incre-ment financing became recognized as a flexible,all-purpose financing tool for economic develop-ment. Today, it helps local governments achievea variety of economic development goals, includ-ing job creation, growth in property values, andprotection of the local tax base. Suburban munic-ipalities even use tax increment financing todayto spur development in “greenfields.”

A survey by the International City/County Man-agement Association1 (ICMA) finds that localgovernment managers cite the most commongoals for a TIF project to be, in order: (1) attrac-tion of new business, (2) downtown redevelop-ment, and (3) retention or expansion of existingbusinesses. Other goals mentioned far less fre-quently were: neighborhood commercial develop-ment, small business development, officedevelopment, service sector growth, and minoritybusiness development. Perhaps surprisingly, al-leviating blight was not cited as an explicit goalin establishing a TIF district.


1 Fred Allen Forgey, “Tax Increment Financing: Equity,Effectiveness and Efficiency,” in The Municipal Year Book1993 (Washington, D.C.: International City/CountyManagement Association, 1993), pp. 25-33.

What are the different types of TIFdistricts?

Tax exempt financings have become so diversethat it is impossible to identify a typical exam-ple. Not only do TIF districts have varying eco-nomic development objectives (as discussed onthe preceding page), but they also can be differ-entiated by financing type, land use, and evensponsoring government.

• Financing type. Property taxes are the mostcommon financing source for TIF and are dis-cussed in this publication. Some governmentshave also established TIF districts using salesor utility taxes as the source of incrementalrevenues.

• Land use. Tax increment financing can be em-ployed for virtually any land use. As an eco-nomic development tool, commercial andindustrial land uses have been common, butsome jurisdictions have established residentialTIF districts as well. In addition, many down-town redevelopment TIF projects result inmixed-use property, combining residential andcommercial (office and retail) land uses.

• Sponsoring government. Many states give stat-utory authority to either counties or munici-palities to establish a TIF district (furtherdiscussed on p. 8).

In addition, TIFs vary by the type of subsidiesemployed (discussed on page 9).


Where is tax increment financingused?

Tax increment financing is used in nearly everystate. In fact, most mid-sized and large munici-palities have one or more TIF districts in opera-tion.2 Currently, forty-nine states allow cityand/or county governments to establish TIF dis-tricts.3 Only Delaware does not permit county ormunicipal governments to use tax incrementfinancing.

In some states, tax increment financing has be-come a routinely used economic developmenttool. Indeed, in Wisconsin and California the in-cremental assessed value exceeds base assessedvalue statewide at the time of this writing.


2 Craig L. Johnson and Joyce Y. Man, eds., Tax IncrementFinancing and Economic Development: Uses, Structures andImpacts (Albany, New York: State University of New YorkPress, 2001), p. 18.3 Ibid, p. 31.

Can local governments other thanmunicipalities establish TIFdistricts?

In most states, the government sponsoring a TIFdistrict – that is, establishing it directly or indi-rectly through a subsidiary redevelopmentagency – is a municipality. A significant numberof state statutes, however, also permit a countygovernment to establish a TIF district. In fact, inHawaii and West Virginia, only counties haveauthority to establish TIF districts.

Single-purpose governments such as schools andwater treatment authorities do not have author-ity to engage in tax exempt financing.


Exhibit 2 • Types of Governments Sponsoring TIFDistricts

Note: In Kentucky, municipal authority is delegated to a redevel-opment agency.

Source: Craig L. Johnson and Joyce Y. Man, eds., Tax Incre-ment Financing and Economic Development: Uses, Structuresand Impacts (Albany, New York: State University of New YorkPress, 2001), pp. 33-34.

Government Authorized to Initiate aTIF District

Numberof States

Municipality only 25

Both county and municipality 21

County only 2

No state authorization 1

What type of projects is taxincrement financing used for?

Governments often use TIF resources to prepareland for development or redevelopment. In addi-tion, governments may use TIF revenues to un-derwrite certain public structures, such asparking garages. If permissible under state stat-ute, the construction of municipal facilities canbe financed using TIF revenues.

An ICMA survey4 finds that site preparationis the most common use of TIF funds. Sitepreparation encompasses land acquisition, landcondemnation, demolition of old structures, andenvironmental remediation. Other common usesof TIF funds are for infrastructure: sidewalk re-placement, curb and gutter installation, and re-lated planning and engineering. In general,governments using tax increment financing tendto provide in-kind subsidies for economic devel-opment rather than tax subsidies to targetedbusinesses. Many of these in-kind subsidies pro-mote a public purpose, and can qualify fortax-exempt financing.


4 Fred Allen Forgey, “Tax Increment Financing: Equity,Effectiveness and Efficiency,” in The Municipal Year Book1993 (Washington, D.C.: International City/CountyManagement Association, 1993), pp. 25-33.

Why has the use of tax incrementfinancing become morewidespread?

As noted, nearly every state has given local gov-ernments authority to establish TIF districts, ei-ther by passing referenda or by enactingenabling legislation. Equally important, thegrowing use of tax increment financing as aneconomic development tool has coincided withthe reduction in federal funding for municipaleconomic development over the past twentyyears. (The Community Development BlockGrant program, for example, has declined signifi-cantly over the past twenty-five years when dol-lars are adjusted for inflation.)

Other factors may have influenced cities to pur-sue tax increment financing. For example, manylocalities have attempted to diversify their taxbase to become less reliant on the property tax.As a way to generate sales tax revenues, tax in-crement financing offers a flexible revenue diver-sification option. Additionally, with growingexperience and success in local TIF projectsthere has developed a cottage industry of advis-ers – TIF planning consultants, attorneys, and fi-nancial advisers for bond issuance – able toassist government officials with implementationof their TIF plans.


How does tax increment financingdiffer from other economicdevelopment financing tools?

Three attributes differentiate tax increment fi-nancing from other financing tools:

• Self-financing—Tax increment financing of-fers a way to dedicate a specific revenuesource to pay for economic development subsi-dies. The incremental revenue expected to oc-cur after businesses move into a TIF districtprovides the resources needed to carry out TIFprojects, thus alleviating the need to establisha separate tax levy or increase tax rates uponresidents outside the TIF district.

• Local control—Tax increment financing pro-ject initiation and management is carried outat the local level. TIF projects are not depend-ent upon federal or state funding.

• Flexibility in project activities—Partly becauseit is not subject to many federal or state re-quirements, tax increment financing can beused for a broad array of activities, such asland assembly, demolition, or environmentalremediation and other in-kind subsidies. Taxincrement financing can also be used to subsi-dize a developer directly through land dona-tions, for example. Moreover, TIF subsidiescan be layered upon non-TIF subsidies offeredby the municipality or state government.


Section IITIF MECHANICS

What is the general process forestablishing a TIF district?

State law generally determines the process forestablishing and operating a TIF. Enabling legis-lation enacted by state legislatures usually speci-fies detailed activities or checklists that localitiesmust comply with. In most states, this includes afinding of need for a TIF, demarcation of the TIFboundaries, and creation of a TIF managementteam or organization. The following bullet pointsoutline the sequence of steps for establishing aTIF district.

• Phase 1: Determine project feasibility

• Phase 2: Create redevelopment plan

• Phase 3: Adopt

• Phase 4: Implement

• Phase 5: Evaluate and terminate

Phase 1, determination of feasibility, is apre-planning stage that serves as a prerequisitefor the more formal and costly planning neededin phase 2. A feasibility study encompasses anassessment of “need” as judged by localpolicymakers and external stakeholders, as wellan assessment of economic benefits.

In phase 2, a formal plan must be developed.This entails:

• Determining the legal boundaries of the TIFdistrict;

• Finding that the TIF district would support astate-mandated public policy goal, such asamelioration of blight or promotion of eco-nomic development;


• Estimating project timeline and costs;

• Establishing the base assessed value and baserevenue; and

• Projecting incremental assessed value and in-cremental revenue.

In addition to a finding of blight, some statesmay require an additional finding that blightremediation or economic development will not oc-cur but for the establishment of a TIF. That is,economic growth will not occur in the absence ofTIF-related subsidies.

Phase 3 occurs when the government formallyadopts the plan and establishes a TIF district. Insome jurisdictions, this may necessitate two sep-arate ordinances and may require action spreadout over several weeks to allow for communityinput. The government may be required to pro-vide a disclosure to overlapping districts affectedby the TIF district (although this is often doneearlier to get preliminary buy-in from other gov-ernments) and to the public, followed by publichearings. During this phase, the governmentalso develops public-private sector agreementsdelineating obligations of the two parties.

In phase 4, a government implements its plan.In many communities, this is the government’sundertaking of site preparation activities thatwere described on page 9 as well as private-sector construction of commercial, industrial,residential, or mixed-use buildings. Project fi-nancing also takes place in the fourth phase: es-tablishment of the tax base and tax rates,issuance of debt, and generation of the tax incre-ment necessary to retire debt.

In phase 5, a government monitors the perfor-mance of the TIF district and reports financialresults to internal management and, if applica-ble, to state oversight bodies. Ultimately, thegovernment would dissolve the district and eval-uate its performance. At this point, the total as-sessed value (base and incremental) would beavailable to all units of government.


What criteria are used to establisha TIF district?

Most states require localities to meet specific cri-teria before a TIF district can go into operation.Historically, many states have required an areato be blighted, as measured in either qualitativeor quantitative terms. For example, the State ofIllinois stipulates that an area is blighted if itmeets a minimum of five of thirteen qualitativefactors.5

• Dilapidation,

• Deterioration,

• Obsolescence,

• Illegal use of individual structures,

• Structures below minimum building codestandards,

• Excessive land coverage and overcrowding ofstructures and community facilities,

• Lack of ventilation, light, or sanitary facilities,

• Inadequate utilities,

• Excessive building “footprint” (structure toobig relative to property),

• Deleterious land use or layout that is consid-ered noxious,

• Environmental clean-up needed,


5 A separate set of criteria is applied to the establishment ofTIFs in vacant land, conservation districts, and industrialparks.

• Declining assessed value, and

• Lack of community planning.

Overall, 33 states require a finding of blight toestablish a TIF. Only seven states, however, re-quire a quantitative finding that measures thedegree of blighted conditions.6


6 Craig L. Johnson and Joyce Y. Man, eds., Tax IncrementFinancing and Economic Development: Uses, Structures andImpacts (Albany, New York: State University of New YorkPress, 2001), p. 38.

What is the “but for” requirement,and how is it defined?

Seventeen states require governments to estab-lish that economic development would not occurwithin a designated area, but for the establish-ment of the TIF district. Stated another way, ifthe government does not provide subsidies to thedistrict, then economic activity will remain stag-nant and hoped-for outcomes (such as increasingassessed value) will not occur. Before the State ofWisconsin can adopt a TIF plan, for example, anintergovernmental review board must considerwhether development would occur with or with-out TIF subsidies. Minnesota state law assignsthe decision to the municipalities themselves.They must establish a two-part finding thata) no development would occur solely throughprivate investment and b) the increased marketvalue of the properties within the TIF districtwould be greater than without the it.

Local government leaders should not view thebut for test as a state-imposed hurdle to over-come. Rather, it should be treated as an impor-tant safeguard for protecting local resources,since it theoretically prevents the misuse of pub-lic subsidies for unproductive purposes. Further,a diligent effort to limit subsidies to businessesthat would locate in a jurisdiction without gov-ernmental support would reduce a point of fric-tion with schools and other localities that couldpotentially be affected by a TIF.

It is difficult to determine with certainty thata TIF solution is truly needed, as it requires(a) predicting the future, (b) determining what atargeted business or businesses will do, and(c) developing a detailed TIF project plan. TheTIF project plan may be the document that iden-tifies, in detail, if TIF subsidies are needed or


not, but ironically it may not be fully developeduntil after the TIF is approved. The but for find-ing is usually made earlier, and does not involvedetailed project planning.


How long are TIF districts inoperation?

The life span for a TIF district can be statutorilydetermined and/or set by the term of the bondsissued to support the TIF projects and activities.Often, TIF districts function for more thantwenty years. A lengthy financing period reflectsthe useful life of the projects and the time re-quired for economic payback.

Some municipalities operating successful TIFdistricts have been able to terminate them aheadof schedule. Clearly, this benefits other govern-ment units that can then begin to share in theincremental revenues associated with a TIF dis-trict. In other cases, municipalities have electedto simply share surplus revenues annuallyrather than terminate the TIF altogether.


Who comprises the TIFmanagement team?

Because tax increment financing is a high profileactivity, the TIF management team usually in-volves the government’s senior executives or theirdelegates. A city or county manager, finance di-rector, and economic development director or co-ordinator generally oversee and administer thedistrict. The economic development director alsomonitors daily TIF performance and ensurescompliance with government-developeragreements.

Governments often rely on external advisors toestablish, monitor, and report on TIF perfor-mance. Governments issuing TIF bonds rely onthe standard set of advisors for a bond issue – fi-nancial advisor, underwriter, bond counsel, andcredit rating agency. Additionally, governmentsrely on specialized TIF consultants to provide de-tailed oversight of a developer’s economic devel-opment plans. This consultant can play animportant role in securing compliance with statestatutes by: a) establishing that TIF blight crite-ria are met; b) performing a due diligence reviewof developer proforma financial projections; andc) ongoing reporting.

Some of the services or deliverables provided bya TIF consultant include:

• TIF plan – identifying major characteristics ofa planned TIF, including the plan budget, de-veloper projects, land use, and years TIF is ineffect;

• Eligibility report – establishing a finding thatstatutory blight criteria, but for criteria, orother criteria are met;


• Feasibility report – assessing the feasibility ofthe developer plans, including a due diligencereview of proformas; and

• Annual TIF reporting requirements mandatedby statute – indicating financial results andother metrics.


How large should a TIF districtbe?

Most states allow localities leeway in how looseor tight the boundaries of a TIF district can be.As a result, governments sponsoring a TIF dis-trict must analyze where the district boundarieswill be set. The arguments for a district with abroad geographic area are:

• It increases the likelihood that the area tar-geted for redevelopment will experience eco-nomic growth;

• It allows the municipality or county sponsor-ing the TIF district to capture more incremen-tal revenues compared to a smaller TIFdistrict; and

• If debt financing is used, it may result in a re-duction in perceived credit risk and a corre-sponding increase in the bond rating.

On the other hand, an excessively broad TIF dis-trict may not be viewed as equitable. Schools andother government units may believe broadboundaries would lead to an inequitable distri-bution of tax revenues. The larger the geographicfootprint of the TIF district, the larger theamount of revenue captured by the municipalityat the expense of other government units.

In addition, there may be efficiency concerns –that is, the sponsoring government may not needto capture revenues that would otherwise beshared with other taxing districts. Moreover, agovernment issuing general obligation debt maynot need to expand the boundaries to ensure ahigh credit rating, if it already has an upper-tierrating on recent bond issues.


How is stakeholder participationincorporated into the TIF process?

Stakeholder participation benefits governmentsby building consensus for tax increment financ-ing projects and reducing the likelihood of poten-tial litigation. In some instances, schools andother government units have sued the govern-ments sponsoring TIF districts because they dis-puted the finding of blight and the contentionthat development would not occur but for the es-tablishment of the TIF district.

In many states, TIF participation is accom-plished through two means. First, the normalmunicipal ordinance process or a specific ordi-nance process is used, requiring advance disclo-sures to the public of TIF plans, financingarrangements, and proposed geographic bound-aries. This may also involve public hearings be-fore enactment of ordinances to gauge publicsentiment. Second, the government sponsoringthe TIF may have to involve other governmentsin TIF planning as well as ongoing oversight. Forexample, a joint review board can be chargedwith monitoring TIF performance, and the com-position of the board would include schools, othergovernments, and/or citizens.

The City of Portland, Oregon, has a well-developedprocess of stakeholder participation. Everyhousehold in the city receives a mailing describ-ing the proposed TIF district (referred to in Port-land as an urban renewal area). The mailingprovides photographs and drawings describingthe boundaries of the area, answers to frequentlyasked questions, and other information to helpcitizens participate in subsequent public hear-ings. Additionally, each of the urban renewal ar-eas has a citizens committee that providesmonthly feedback to municipal managers.


Section IIIEVALUATING TIFS

What are the general advantages oftax increment financing?

Tax increment financing offers a number of ad-vantages to localities. First and foremost, inmany jurisdictions the technique has been usedto finance successful economic development pro-jects. This is not to say that they always are suc-cessful; there is substantial risk in selecting andimplementing TIF projects. Many additionalbenefits flow from the economic developmentbenefit, such as increases in local revenues thatdiversify and strengthen the tax base.

Additionally, tax increment financing is a flexi-ble tool: the decision to establish a TIF district ismade at the local level with no approvals usuallyrequired by federal and/or state governments.Although some states impose a rigorous processto establish a TIF district, it is usually the localgovernment itself that takes the steps necessaryto complete the process. In contrast, federal andstate grant programs (such as enterprise zones)usually require a grant application and approvalprocess that considerably lengthens the timeneeded to execute a development project. More-over, such programs may be competitive, sincestate and federal grants, tax credits, and subsi-dies usually have resource limits. This flexibilityis using tax increment financing allows manymore municipal and county governments an in-creased opportunity to establish TIF districts.

Another aspect of flexibility is that tax incre-ment financing can be combined with other eco-nomic development subsidies. For example, somemajor economic development projects triggerstate involvement (e.g., for a major distributionor manufacturing facility). In such situations, lo-cal TIF subsidies can be layered upon state sub-


sidies and even other local subsidies like taxabatements.

A third feature that makes tax increment financ-ing attractive is that it does not require a directincrease in property tax rates. The incrementalrevenues that are derived from a TIF project areobtained by applying the same tax rate as in therest of the municipality to new businesses thatenter the TIF district. Governments, TIF consul-tants, and credit rating agencies as part of theirdue diligence will forecast TIF revenues usingthe same tax rate or possibly even a decliningtax rate if state limits on local property taxesmandate such rate reductions. As a result, tax-payers outside the TIF districts will not see a di-rect increase in their property tax rates in orderto finance TIF projects.7 Some TIF proponentsview TIF projects as self-financing for thisreason.


7 Indeed, this advantage can become a disadvantage, sincethe unit of government sponsoring the TIF lacks the abilityto increase tax rates in the TIF if it is not as robust asprojected.

What are the disadvantages of taxincrement financing?

Tax increment financing has several drawbacks,some of which are related to the perceived ad-vantages. First, poorly designed or poorly imple-mented TIF plans may not always be financiallysuccessful, and there is a substantial risk thatthey will fail. A clear measure of risk is that in-vestors will demand a risk premium when buy-ing TIF revenue bonds that are supported onlyby incremental revenues. Governments often areunable to obtain a credit rating on such bonds.

Second, even financially successful TIF projectsmay not be successful in an economic sense. Gov-ernments providing TIF project subsidies to busi-nesses located in a growth corridor experiencingnatural economic expansion may be wasting dol-lars if the businesses would have located andprospered in that area anyway – with or withoutsubsidies. Such TIFs fail the but for test.

In this regard, TIF economic development subsi-dies share the same drawbacks as other localeconomic development incentives. Critics alsohighlight these potential drawbacks of economicdevelopment incentives and tax incrementfinancing:

• They may be ineffective, since economic devel-opment incentives do not generally sway busi-ness location decisions, which are drivenprimarily by market factors (such as the needto be close to consumers or close to a skilled la-bor force);

• They are inefficient, because TIF subsidies:

− Create a zero-sum game in which busi-nesses, especially retailers, locate in one


jurisdiction providing a subsidy at the ex-pense of a neighboring one refusing toforego a subsidy;

− Interfere with the free market forces thattheoretically bring about a more efficientallocation of capital and better locationdecisions.

Third, any TIF district failing the but for testresults in an opportunity cost to other govern-ments. Schools and other units of governmentssharing the same tax base with the TIF-sponsoringgovernments will not share incremental reve-nues (unless provisions require the TIF sponsorto revenue-share) until the TIF district is dis-solved many years later. Further, excessivelylarge TIF districts may allow the TIF sponsor tocapture incremental revenues that would other-wise be shared with the overlappinggovernments.

The loss of actual or potential revenues raises afourth issue. Schools and similarly situated gov-ernments that lose revenues captured by the TIFsponsor may have to respond by increasing thetax rate to compensate for a stagnant tax base.Thus, although there may be no direct increasein tax rates, there may be an indirect tax rate in-crease later.


Why is tax increment financingcontroversial?

The very growth in the use of tax increment fi-nancing has caused an attendant concern aboutits appropriateness as a public policy tool. Aslong as TIF was a niche tool used in few states, ithad minimal impact and raised few policy con-cerns. With the rise of TIF districts nationwide,critics have identified several issues that makethem controversial. Some of the major controver-sies include:

• Whether TIF districts are an effective tool foreconomic development;

• Whether their use creates inequities among lo-cal governments, with the capture of incre-mental revenue often being contested byschools;

• Whether tax increment financing creates ineq-uities among property owners within a TIFdistrict, since certain land uses are often fa-vored over other land uses (e.g., potentiallyeliminating residential housing to build com-mercial properties); and

• Whether TIF districts create an uneven play-ing field between businesses that lie withinand outside its borders.

Elected officials considering the establishment ofTIF districts need to anticipate these controver-sies and be prepared to address them by consult-ing with affected parties early in the planningprocess.


How are TIF projects assessed andmonitored?

Many governments use measures to monitor theimplementation of a TIF district and its ultimateimpact upon a community. Like measures ofother government programs, they can be catego-rized as measures of:

Inputs or resources used – This reflects budget-ary resources provided to initiate and operate aTIF district, and includes in-kind subsidies (seepage 9 on the types of TIF subsidies), financialsubsidies, hard costs for construction, and softcosts for TIF planning and regulatorycompliance;

Outputs or workload – This measures the level ofgoods or services provided by the governmentand its economic development partners, such ascommercial office space created by TIF; oftenthese are embedded in a government-developeragreement that requires a developer to meet cer-tain performance measures before the release ofgovernment funds (see page 56);

Efficiency – This measures outputs against in-puts or resources used, such as dollar per squarefoot of commercial office space; such measures al-low for comparisons over time or against othergovernments operating TIF districts or againstmarket benchmarks (e.g., cost of office spacewithout subsidies);

Effectiveness – This measures the effect of a TIFproject against its goal, such as blight reduction;it also can measure TIF service quality as per-ceived by customers.


Additionally, some governments and other par-ties involved in TIF projects may use risk mea-sures to ensure that TIF projects are successful.

The following exhibit lists examples of measuresused to monitor economic developmentobjectives.


Exhibit 3 • TIF Measures

Measure Examples

Input Public investment ($)

Private investment ($)

Acres of land assembled for TIF

Environmental remediation costs

Bond proceeds

Output/Workload Jobs created or retained

Number of streetscaping fixtures installed

Commercial space created (square feet)

Hotel units

Acres of land remediated

Parking garage spaces

Efficiency Leverage ratio (private investment / pub-lic investment)

Cost per square foot of commercialspace

Cost per parking garage space

Public subsidies per job created/retained

Surplus TIF dollars as a percent of an-nual incremental revenues

Effectiveness Assessed value (AV) within TIF versusAV in rest of city

Assessed value within TIF before and af-ter TIF creation

Municipal sales taxes before and afterTIF creation

Risk Debt coverage ratio

Credit ratings of anchor tenants

Tenant diversification (e.g., percent of to-tal TIF AV attributable to top ten tenants)

How effective is tax incrementfinancing as an economicdevelopment tool?

Over time, tax increment financing has beenused to achieve an increasing number of publicpolicy goals. From its original use to combatblight, TIF has evolved into an all-purpose eco-nomic development tool employed as much inprosperous communities as in disadvantagedones, and toward a variety of ends (the creationof California residential housing, for example).

As a tool purely for economic development, how-ever, there is conflicting evidence about effective-ness. TIF impacts cannot easily be evaluatedbecause the projects that they help finance varysignificantly from state to state and jurisdictionto jurisdiction. TIF districts that promotemixed-use, downtown redevelopment represent avery different approach to economic developmentcompared to districts creating, for example, lightindustrial development on previously vacantland on the suburban periphery. In this sense,tax increment financing is not really one tool butan umbrella for many different tools using thesame financing technique.

Despite these caveats, some researchers have at-tempted to assess a variety of TIF strategies todetermine if they collectively have increased eco-nomic activity above and beyond the rate of eco-nomic growth in the rest of the jurisdiction. Forexample, one small-scale study8 compared therate of growth in property values (a measure ofeconomic development used for the study) withinfive Chicago TIF districts against values outsidethe TIF boundaries (within Chicago), finding


8 Assessing the Impact of Tax Increment Financing inNortheastern Illinois, The Civic Federation, March 1997.

that values had grown faster within all districts.A second study reached a similar conclusion forsuburban Chicago. As indicated in Exhibit 4 be-low, the municipalities used a variety of eco-nomic development approaches, such as creationof shopping malls, industrial development, andother land uses.


Exhibit 4 • Evaluation of Chicago-area TIFs

Note: AV=assessed value. AV growth reflects annual averagesfrom base year to 1995. Each TIF has different base years.

Source: Civic Federation

TIF Type

Size ofDistrict

(in acres)

Growth inAV within

TIF(percent)

Growth inAV

outsideTIF

(percent)

City of Chicago

1 Shopping mall/commercial strip

6 11 5

2 Industrial/commercialstrip with distributor

3 34 5

3 Mixeddevelopment

75 14 2

4 Central business dis-trict redevelopment,mixed use

25 16 6

5 Mixed develop-ment/industrial

127 11 1

Suburban Chicago

6 Mixeddevelopment

23 7 6

7 Mixeddevelopment

17 41 6

8 Central business dis-trict

18 23 6

9 Industrial 153 33 6

10 Central businessdistrict

123 24 5

Note that these studies use comparative growthin assessed value as a proxy for effectiveness.While it is clear that in these cases assessed val-ues grew faster within the TIF districts than out-side them – in several cases substantially faster– the findings cannot be extrapolated to other ju-risdictions. A broader study attempted to mea-sure the impact in 79 Illinois municipalities.Contrary to Exhibit 4, it found that in nearlyone-third of the municipalities, assessed valueswithin the TIFs grew more slowly than outsidethe districts.

Moreover, it remains unclear what the valua-tions would have been within the districts if nosubsidies had been provided all. It is possiblethat they would have been the same with orwithout TIF-based subsidies. To answer the butfor question, it is necessary to go beyond simplecomparisons of assessed valuations to use statis-tical techniques such as multiple regressionanalysis. Using multiple regression, the study of79 Illinois municipalities found no statisticallysignificant effect of tax increment financing uponassessed values. Although there may have beensuccessful TIF districts in a few jurisdictions, theaggregate results show no positive impact.


Section IVFINANCING TIFDISTRICTS

How are TIF expendituresfinanced?

Municipalities can use one or more of the follow-ing options to finance TIF projects:

• Pay-as-you-go financing;

• Developer financing;

• Municipal financing;

− Revenue bonds

− General obligation bonds and

• Municipal financing with developerparticipation.

Pay-as-you-go financing involves expendituresthat are undertaken as incremental revenue isrealized. Although pay-as-you-go financingavoids the costs and risk associated with debt fi-nancing, it does not allow for major, up-front in-vestments often needed to make a TIF effortsuccessful – such as land assembly, municipal in-frastructure, or parking garages.

Developer financing is a means for a municipal-ity to shift the risk of debt financing to a devel-oper. Under this method, the developer incursthe risk of issuing debt and related issuancecosts. A government then reimburses the devel-oper for TIF-eligible costs as it obtains incremen-tal revenues. Alternatively, the municipalitymay negotiate a loan from the developer, al-though such loans tend to cost more than munic-ipal-issued debt.


Because of the limitations associated with theother financing methods, governments often willissue bonds to finance TIFs. While the munici-pality incurs long-term obligations that limit itsfinancial flexibility to issue debt for othernon-TIF projects,9 this option allows the govern-ment to undertake costly, non-routine projectsoften needed early in the lifecycle of a TIF.

Another alternative is for the municipality toissue the bonds while the developer simulta-neously pledges to purchase all or a significantportion of them. This guarantees a market andcan keep interest and issuance costs low, whiledemonstrating the developer’s faith in the pro-ject. For example, one city issued bonds thatwere purchased by the developer and were tax-able while the developer held them (during theinitial stages of the TIF site redevelopment). Insuch a situation, once the TIF district begins toproduce a reliable revenue stream, the cityremarkets the bonds to new investors on atax-exempt basis. This method mitigates thecity’s risk, particularly in the early phases of theTIF district, while providing an opportunity forlow-interest financing in the long term.


9 This is especially true for GO bonds, as opposed to revenuebonds. Issuing more GO debt will reduce the government’scapacity to issue future GO debt for other municipal projects.

What is a feasibility analysis andproforma?

A financial feasibility analysis represents a criti-cal step in moving from general to specific plan-ning of a TIF. The analysis results in a year-by-year projection of the government’s costs andrevenues for all projects in the district. Althoughit would obviously show incremental propertytax revenues, the analysis should incorporateother revenue sources that may increase afterthe TIF is operational, such as sales taxes, ho-tel/motel taxes, entertainment taxes, and park-ing fees (if a municipal parking garage is built).The feasibility analysis is important not only fordetermining projected TIF costs and benefits,but also because it helps the city determine thelevel of developer subsidies needed to make theTIF work.

To estimate overall annual revenues for a feasi-bility analysis, the government needs to performa bottom-up analysis of individual properties(parcels) in a TIF district and their respectivecontribution toward revenue growth. Exhibit 5describes the property and sales tax contribu-tions toward TIF revenues, once they areoperational.

In addition to determining the revenue impactof individual TIF properties, governments needto determine project timing. This requires esti-mating (a) the pace of construction, (b) market“absorption,” and (c) the lag time from whenproperties reach the market to when they areassessed and taxes collected.


The proforma is a developer document thatshows its expectations of the project’s financialperformance (see Exhibit 6). When the TIF hasonly one developer and only one project, theproforma feeds directly into the government’sfeasibility analysis. When there are multiple


Exhibit 5 • Simplified TIF Feasibility AnalysisY

ear

1Y

ear

2Y

ear

3Y

ear

4Y

ear

5Y

ear

6Y

ear

7

Pro

pert

yTax

Incre

ment

$0

$500,0

00

$1,0

00,0

00

$1,2

00,0

00

$1,4

00,0

00

$1,6

00,0

00

$1,8

00,0

00

Sale

sTax

$0

$50,0

00

$100,0

00

$102,0

00

$104,0

40

$106,1

21

$108,2

43

Hote

lTax

$0

$100,0

00

$200,0

00

$206,0

00

$212,1

80

$218,5

45

$225,1

02

Subto

tal–R

evenues

$0

$650,0

00

$1,3

00,0

00

$1,5

08,0

00

$1,7

16,2

20

$1,9

24,6

66

$2,1

33,3

45

Soft

Pro

jectC

osts

(exte

rnal)

$100,0

00

$100,0

00

$25,0

00

$25,0

00

$25,0

00

$25,0

00

$25,0

00

Inte

rnalS

taffin

g$50,0

00

$50,0

00

$10,0

00

$10,0

00

$10,0

00

$10,0

00

$10,0

00

Tota

lD

ebtS

erv

ice

$0

$0

$0

$2,0

00,0

00

$2,0

00,0

00

$2,0

00,0

00

$2,0

00,0

00

Subto

tal–P

roje

ctC

osts

$150,0

00

$150,0

00

$35,0

00

$2,0

35,0

00

$2,0

35,0

00

$2,0

35,0

00

$2,0

35,0

00

Netre

venues

-$150,0

00

$500,0

00

$1,2

65,0

00

-$527,0

00

-$318,7

80

-$11

0,3

34

$98,3

45

developers with multiple proformas, the govern-ment must combine the data into one document.

Developers expecting to receive public subsidiesshould be willing to divulge information in theproforma. Although the developer bears the bur-den of preparing the proforma, government offi-cials should remember that the developer has astake in the outcome and cannot be expected tobe completely impartial. The government mustperform its own due diligence on the developer’snumbers, comparing them to market benchmarksand to previous actuals from similar projects un-dertaken by the developer.


Exhibit 6 • Feasibility Analysis Component –Operational TIF Projects

ParcelProject

Description

SquareFeet/Units

AverageMarketValue

SquareFeet

Gener-atingSalesTax

AverageSales

SquareFeet/Units

Parcel 1 Residential 150units

$300,000per unit

0 0

Parcel 2 Bookstore

20,000sq.ft.

$100 20,000 $300

Parcel 3 Grocer 11,000sq.ft.

$100 11,000 $600

What factors determine whether aTIF revenue projection is accurate?

There are at least three critical factors that en-able governments to generate accurate revenueestimates from TIF projects:

Market values. TIF properties often have abenchmark value or range familiar to experi-enced economic development officials or TIFconsultants. As indicated in Exhibit 6, certainformulas or benchmarks are used, such as dollarper residential unit, or sales tax per square foot.A precise estimate requires knowledge of specificresidential or commercial market niches, as wellas reasonable estimates of value for each niche.10

This specialized knowledge is important: a TIFconsultant familiar with the market values forentertainment-based TIF projects may not haveknow the market values for hotel projects, forexample.

Absorption rates. Commercial or residentialspace created in a TIF district is not immediatelybuilt or absorbed by the marketplace. In somecases, TIF properties are phased in over severalyears. A sound revenue estimate takes into ac-count construction schedules, regulatory approv-als (such as building permits), tenant lease-uprates, and other factors that determine whenunits hit the market.

Familiarity with the assessment process. Often,the government sponsoring a TIF district is notthe entity that assesses the taxes. Officials of thesponsoring government need to become knowl-


10 Significant deviations from historical, industry, or marketbenchmarked metrics should be carefully investigated by theissuing government and validated or explained by thedeveloper.

edgeable about assessment practices since thetiming of expected revenues is directly affectedby it. They must be able to accurately determinethe lag time from when a TIF property is valuedby the market (that is, when a transaction oc-curs, such as sales or lease of commercial spaceto tenants) to when it is valued by the govern-ment. In states where the assessment is not con-ducted annually, there is a significant lag timebetween market valuation and assessment valu-ation. TIF consultants can be engaged to helpwith this analysis.

Many larger governments have a revenue fore-casting division. While a revenue forecastingstaff may be useful (e.g., in terms of understand-ing administrative provisions of taxes), the reve-nue estimation techniques they use may notreadily apply to TIF district revenue forecasts.(For example, the revenue forecasting staff mayuse top-down revenue estimation models or ec-onometric techniques that are applied to histori-cal revenues for the entire jurisdiction. Revenueforecasting for a TIF requires a bottom-up ap-proach where the revenue estimate is developedparcel by parcel, relying on knowledge of indus-try trends.)


What happens to TIF surplusfunds?

Successful tax increment financing projects gen-erate annual revenues that exceed yearly costs,so that over time a surplus can accrue to the gov-ernment. True surpluses need to account for obli-gations that may not necessarily trigger animmediate disbursement of funds, but are none-theless potential claims on TIF resources. For ex-ample, the government may have bondcovenants establishing that it will maintain adebt coverage ratio of, for example, 1.5 (annualrevenue inflows are 1.5 times debt service out-flows). Tax objections represent another poten-tial claim on resources.

Governments have at least two options when de-ciding how to allocate surplus funds. First, thegovernment can continue to build annual sur-pluses that grow over time. This option gives thegovernment the potential to call or retire bondsbefore the scheduled maturity date. Overlappingunits of government are then able to share in theincremental taxes after the TIF is dissolved.

Second, it can disburse surplus funds to othergovernment units, either on an ad-hoc or formalbasis. Formal revenue sharing with local govern-ments may be mandated by state law or can benegotiated when the TIF is formed. Althoughthese formalized arrangements may also benefitoverlapping taxing districts, they represent aclaim on TIF resources and increase risk tobondholders (if bonds are issued) and could po-tentially raise the government’s borrowing cost.This option is likely to extend the TIF district’slife span.


What types of TIF-related bonds dogovernments issue?

Tax increment or tax allocation bonds representdebt financing for TIF-related projects. Althoughsometimes defined as bonds solely supported byincremental revenues, here it is defined morebroadly to include bonds supported by:

• Incremental revenues (revenue bonds);

• The full faith and credit of the issuer (generalobligation bonds); or

• A mix of the two.

Governments may support TIF bonds not onlywith incremental property tax revenues (whichare often formally pledged) but also with salestax and other revenues that are projected to in-crease during the life of the project. TIF-relatedbonds can be issued either by the city or countygovernment that sponsors the TIF, or in somestates by a redevelopment agency (typically asubsidiary of the government) empowered to is-sue bonds.

There is a tradeoff between the risk of the fi-nancing instrument and the interest rate. A gov-ernment can absorb the risk of a bond issuanceby issuing general obligation (GO) bonds, extend-ing its full taxing powers to support the bond is-sue, and thereby reducing the risk to bondholders.While this results in a lower interest rate, gov-ernments in fact are taking on the risk that theTIF project will be financially viable. If it fails,government taxpayers are still responsible forretiring the bonds and would have to draw upongeneral fund revenues.


TIF revenue bonds are not backed with a fullpledge of the sponsoring government. Althoughthey lower the government’s exposure to pro-ject-failure risk, they shift the risk to investorsunderwriting the bond. As a result, such bondstypically command a higher interest rate. Thesecosts can be mitigated in cases where the devel-oper pledges to purchase the bonds.

Some finance officers observe that TIF revenuebonds, while not resulting in a formal pledge offull faith and credit, may create a moral obliga-tion in the event a TIF project fails. In this sce-nario, a TIF project that does not producesufficient revenue to retire a revenue bond wouldcreate a moral obligation to use general fund re-sources to make timely payments on a revenuebond.


Exhibit 7 • Comparison of TIF Bonds

Type of TIFBond

Risk toGovernment

IssuerRisk to

bondholderInterest

Rate

GO Greater Lesser Lower

Revenue Lesser Greater Higher

How are TIF bond proceedsinvested?

Governments can invest TIF bond proceeds us-ing either a segregated account (such as a trustarrangement) or in a pooled account. Some gov-ernments pool or commingle bond proceeds withother surplus funds – funds not needed for im-mediate operating needs or immediate disburse-ment – that a government invests for operatingpurposes. The City of Portland, Oregon, for ex-ample, pools bond proceeds on behalf of the Port-land Development Commission with other citydollars not required for immediate use or dis-bursement. The city is able to obtain economiesof scale in investment and reduced transactioncosts by commingling funds, while providing sep-arate investment accounting for TIF funds.

Like other investments, bond proceeds are gov-erned by state statutes and local investment pol-icies that establish a number of controls over theinvested assets.11 For example, investment poli-cies will typically impose the following require-ments to manage investment risk:

• Diversification requirements (e.g., a limit onthe number of securities purchased by oneissuer);

• Credit quality requirements; and

• Limits on maturities.

Government investment officials ensure that theportfolio has sufficient liquidity to meet sched-uled disbursements, such as payments for debtservice, payroll, or vendor services. This requires


11 Investment options may also restricted by provisions in abond ordinance and/or indenture.

the government to develop a detailed cash flowforecast before implementing an investmentstrategy, and then executing a strategy that gen-erates needed liquidity. Investment techniquessuch as bond laddering or disbursement match-ing are examples of strategies that can providedesired liquidity.

Although bond proceeds can be pooled with othersurplus funds, the investment of the proceeds isdifferentiated by two important factors. First,bond proceeds may have a different, possibly lon-ger investment horizon. Since the government is-suing TIF bonds may have a debt repaymentschedule that extends over twenty years or more,bond proceeds can be invested much further outon the yield curve if desired. Second, the regula-tory framework is different: government invest-ment officials need to comply with federalarbitrage regulations and bond agreements orcovenants that determine the parameters of theinvestment program.


What criteria do rating agenciesuse to evaluate tax incrementbonds?

Rating agencies generally rate bonds upon foursets of broad criteria. These criteria are espe-cially relevant to general obligation bonds issuedfor a TIF district, but they generally apply toother TIF-related bonds as well.

1. Quality of administration – These qualitativefactors take into account the soundness of agovernment’s general and financial manage-ment, such as establishment of rigorous an-nual and capital budgeting, adherence toinvestment policies, maintenance of effectiveemployee relations, and other practices.

2. Debt indicators – These include debt capacityand using indices for existing and projecteddebt levels (e.g., direct debt, debt per capitaetc.).

3. Financial performance – This factor assessesthe government’s budgetary performance, ex-amining trends in revenues, expenditures, re-serves, and fund balance as well as othermeasures.

4. Economic base – This factor considers thestrength of the private sector supporting gov-ernment-sector services. Measures include in-come, population, annual building permits,employment levels, and major taxpayers. Al-though the government does not have directcontrol over the economic base of its area, eco-nomic development efforts can serve tostrengthen it.

When evaluating the creditworthiness ofTIF-related bonds that are supported only by in-


cremental revenues (non-GO bonds), ratingagencies consider additional risk factors. Thesefactors include:

• Tax base concentration – A tax increment dis-trict often depends upon just a handful oflarge taxpaying businesses, such as a shop-ping mall’s primary or anchor tenants; credit-worthiness is enhanced by a greater numberand more diverse variety of taxpayers.

• Market competition – Certain firms, such asretail businesses, may be subject to intensecompetitive pressure, or may face unexpectedcompetition mid-way through the life of theTIF project. When this happens, the firm’srevenues are eroded, which in turn depressesincremental property taxes and, if applicable,sales taxes.

• Revenue or rate limitations – With most TIFs,the government or redevelopment agency op-erating the TIF district cannot increase thetax rate to compensate for an erosion in thetax base. Any change in state law governingproperty tax revenue (e.g., limiting increasesin assessed value) makes it difficult for gov-ernments to realize projected incrementalrevenues.

As mentioned, debt indicators are a rating crite-rion generally applicable to any bond issue, butthese may be given somewhat greater weightingfor TIF bonds supported only by incrementalrevenues.


What risks do bondholders face inbuying TIF bonds?

Like any bonds, TIF bonds present three risks toinvestors: market risk, credit risk, and eventrisk. Both general obligation (GO) and non-GOTIF bonds pose these risks, but credit risk is ofparticular concern with the latter. All threetypes of risk are reviewed below:

Market risk – Market or interest rate risk is therisk that a bond will drop in value when prevail-ing interest rates rise; there is little that an in-vestor can do to manage this risk other than toshorten the duration of his or her municipalbond portfolio; likewise, there is little that a gov-ernment issuing bonds can do to help investors,except to issue variable rate bonds.

Credit risk – Credit risk is the possibility of theissuer not making payments to bondholders, infull and on time; investors can manage risk bypurchasing highly rated bonds and diversifyingtheir bond portfolio; governments can help inves-tors by either pledging full faith and creditand/or obtaining municipal bond insurance.

Event risk – Although rating agencies assess thecredit risk that is measurable and can be pro-jected forward over several years, some riskscannot be measured or predicted based on avail-able data. For example, natural disasters, fraud,or malfeasance – such as that committed by Or-ange County, California, officials in 1994 – areinherently unpredictable.

Bondholders are compensated for the risks thatthey take when purchasing the bonds, and theriskier the bonds, the greater the compensation.The compensation is reflected in the interest ratespread between the TIF bond issue and a low-risk security such as a Treasury bond.


What can governments do to obtaina better credit rating?

Bonds supported only by incremental tax reve-nues are often viewed as poor credit risk, and arenot likely to be rated investment grade. As a re-sult, governments often will not seek a creditrating and the bonds will necessarily be sold at ahigher interest rate.

A government that desires a rating, however,can take several steps to improve its credit rat-ing (apart from pledging full faith and credit).First, it can establish a higher debt coverage ra-tio, which is the ratio of annual tax increment di-vided by annual debt service.

Second, it can expand the TIF boundaries to in-crease the number of taxpayers and reduce thetax base concentration. Standard & Poor’s ob-serves that a larger district, generally exceeding150 acres, is typically more creditworthy.

There are practical limits to expanding TIFboundaries. From a public policy standpoint, thepractice could violate the but for objective, sinceexpanding the TIF would allow the governmentto tap incremental revenues from additionalproperties that are growing without any subsi-dies. It could also engender opposition fromschool districts and other overlapping govern-ments that would lose incremental revenuesfrom these areas.


Is there an ideal debt coverageratio for bonds supported byincremental revenues?

There is no hard and fast rule for what the debtcoverage ratio should be. One rating agency,Fitch Ratings, uses two tests to determine if anon-general obligation TIF bond will be invest-ment grade:

• Net incremental revenues to the governmentissuing the bond must be at least 100 percentof the level of debt service in the year preced-ing debt issuance; and

• Net incremental revenues in the followingyear must be at least 110 percent of debtservice.

Net incremental revenues are revenues availablefor debt service, after deducting revenues thatare shared with other governments (e.g. in Cali-fornia, a percentage of incremental revenues isearmarked for low-income housing and in manystates municipalities form a revenue sharingagreement with schools). Debt coverage ratiosmay need to be adjusted upward if the TIF pres-ents unique risks, such as excessive tax baseconcentration.

Governments can act to increase debt coverageratios. At the front end it can be achievedthrough careful selection of TIF developments,and rejection of developer proposals that will notengender sufficient revenues to achieve a highdebt ratio. At the same time, the government cansize the bond issue so that it results in a level ofannual debt service that produces a target debtcoverage ratio.


In addition, governments can wait to issuelong-term debt until incremental revenue is ac-tually collected and disbursed to the governmentsponsoring the TIF district. At that point, the in-cremental revenues would no longer be consid-ered speculative and the government would beable to demonstrate the TIF district’s financialstrength.


What documents do rating agenciesneed to evaluate tax incrementbonds?

Rating agencies need a variety of documents notonly to determine ratings at the time of bond is-suance, but also to judge whether ratings shouldbe upgraded or downgraded in the future. TIF-sponsoring governments have many of these doc-uments on hand, since they are needed to per-form their own due diligence:

TIF documentation

• City council resolutions or ordinances estab-lishing the TIF district, enacting the TIF plan,and approving TIF bond issuance;

• Agreement or agreements between the govern-ments and developer(s);

• Intergovernmental agreements, such as forrevenue sharing;

• Tax collection agreements;

• Market studies and or project feasibility stud-ies; and

• Sample tenant leases (e.g., between the devel-oper and anchor tenants).

Bond documentation

• Trust indenture/resolution;

• Loan/lease agreements;

• Official statements;

• Surety or revenue insurance;


• Debt service cash flows; and

• Information about the bond insurer.

In addition, for tax increment bonds issued aftera TIF project is producing revenue – that is, amature TIF – rating agencies may request an-nual financial audits or reports issued to stateoversight bodies, if applicable.


Will insurance companies providecredit enhancement for taxincrement bonds?

Municipal bond insurance companies providecredit enhancement for only certain types of TIFbonds. They are likely to insure TIF general obli-gation bonds that are backed by a governmentpledge of full faith and credit. In addition, theymay insure TIF bonds that are backed only bythe pledge of incremental revenues. In the lattercase, however, it may be necessary for the gov-ernment to first obtain an investment gradecredit rating (BBB or better, for example).Should the government be unable to obtain aninvestment grade rating, or should the bond beunrated, a bond insurance company likely willdecline to provide credit enhancement.12

It can be beneficial to obtain credit enhancementfor a TIF bond issue. Generally, the applicationof credit enhancement to the government’s bondissue raises the rating to a top tier, such as AAA.This results in a significant reduction in theyield necessary to attract investors. This yieldreduction (measured in basis points) translatesinto a reduction in annual payments of principaland interest, which would have to be comparedagainst the premium paid to the bond insurancecompany. According to one large municipal bondinsurer, governments generally break even onbond insurance premiums around the mid-pointof the bond repayment period (e.g., in year 10 ofa twenty-year bond issue).


12 TIF projects that have a proven revenue stream are morelikely to obtain a credit rating.

What are the benefits of a financialpolicy governing tax incrementfinancing?

Most local governments have policies that deter-mine how they invest assets for cash manage-ment or pension objectives, yet few have policiesthat govern how tax dollars are invested for eco-nomic development or tax increment financing.This is true despite the fact that government eco-nomic development subsidies represent undiver-sified, risky investments costing millions ofdollars each year in outlays or foregone taxes.

Although not widely used, TIF policies offer anumber of benefits to governments:

• Like any financial policy, they strengthen thegovernment internal control environment.

• They establish a level playing field for all de-veloper proposals. Many times a TIF district isnot initiated by a municipality, but rather by adeveloper requesting public assistance. Estab-lished policies help the government deal con-sistently with all developers.

• They help ensure that public subsidies are notsquandered on high-risk, low-return invest-ments by guaranteeing that newer staff haveguidelines on historical practice, and that thepertinent data collection and analyses are car-ried out.

• They help coordinate TIF planning with otherplanning processes, such as the annual budgetcycle.

• They offer a bridge between city strategicplans and objectives and the activities neededto realize them.


The City of Minneapolis, Minnesota, has estab-lished a detailed TIF financial policy that pro-vides many of the benefits mentioned above. Itsets policy goals and objectives and identifies keydecision makers responsible for TIF project eval-uation. Moreover, the policy spells out techniquesfor evaluating TIF projects that go beyond statestatutes to provide detailed guidance to economicdevelopment staff. It also contains general guide-lines that establish pay-as-you-go financing as apreferred financing tool over debt financing.

The policy also details economic and risk analy-sis criteria to protect the city’s financial inter-ests. It contains economic criteria for projectselection that build on the basic blight and butfor criteria in state law. For instance, the policyrequires that the city compare the ratio of publicto private investment against other city pub-lic-private partnerships to determine if it is rea-sonable. It also mandates that staff carry outquantitative cost/benefit analysis as a standardpractice.


How does a government protect itsfinancial position vis-à-vis adeveloper?

Depending on the type and scale of a TIF project,a government may seek the services of a devel-oper that will manage a TIF project. To a greatextent, the success or failure of a TIF projecthinges on the government’s ability to prudentlyselect a qualified developer and then properlystructure the relationship. Central to structuringthe relationship is a sound municipal-developeragreement that protects the government’s finan-cial position during all project phases.

A qualified developer will have the requisite ex-perience for the type of TIF project envisioned bythe government. For example, a developer expe-rienced in downtown redevelopment would notnecessarily be a good fit for a government seek-ing to build new construction on previously va-cant land on the suburban periphery. Accordingto a bond underwriting firm experienced in taxincrement financing, a developer should haveverifiable experience in:

• Managing construction of projects similar insize, scope, and use to the one anticipated bythe government, having successfully met pro-ject milestones;

• Lease-up and tenant retention of projects sim-ilar to the government’s; and

• Post-construction management and sitemaintenance.

Additionally, the government should verify thatthe developer and/or its subsidiary corporationassigned to the government’s TIF project has the


financial capacity to meet its financialcommitments.

A government needs to exercise due diligence incrafting a municipal-developer agreement. Im-portant provisions include, but are not limited to,the following:

• Putting construction and permanent financingin place before the expenditure of any govern-ment moneys or the conveyance of land;

• Obtaining long-term leases from importanttenants, such as anchor tenants;

• Obtaining an as-built appraisal of the prop-erty, using a government-selected appraiser;

• Disclosure of the amounts and sources of all ofthe developer’s project funds;

• Agreeing on a schedule for releasing publicfunds, so that the ratio of disbursed public/pri-vate funds is kept constant through construc-tion phases;13 and

• Monitoring compliance with performance mea-sures in the agreement (such as constructionof a certain amount or percentage of residen-tial units or commercial office space by a spe-cific date) and imposing penalties fornon-compliance.


13 For additional information on structuring the developerrelationship, refer to Thomas Gavin, Tax IncrementFinancing: A Primer for City Policymakers, a white paperpublished by Robert W. Baird Incorporated; and KurtFroehlich, “Practical Considerations in Negotiating andDrafting Development and Redevelopment Agreements,” TheUrban Lawyer, (Fall 1994): 73.

GFOA RECOMMENDEDPRACTICE

Economic Development Incentives(1990)

Background. Economic development incentivesare tools used by state and local governments toretain or attract jobs and/or tax base. There areexpenditures and/or opportunity costs as well aspotential or actual benefits associated with theseincentives. These costs and benefits often do notclearly appear in a budget or financial state-ment, and if they do, the overall impact of theseincentive costs and benefits often take place overmany years.

Recommendation. The Government FinanceOfficers Association (GFOA) recommends thatany jurisdiction’s economic development incen-tives have specific goals and criteria that serveto define the economic benefit both the govern-ment and the entities receiving the incentivesexpect to gain from the incentives, the conditionsunder which the incentives are to be granted,and the actions to be taken should the actualbenefits differ from the planned benefits.

For any specific economic development incentive,it is recommended that the economic benefit tothe government, as well as the cost of the incen-tive, be measured and compared against thegoals and criteria that have been previouslyestablished.


APPENDIX

Profiles of TIF Districts

Jurisdiction: City of Portland, Oregon

Goal:The district (referred to as an urban renewalarea) is adjacent to the southern edge of thedowntown, containing vacant parcels or tractsthat had been underutilized. The goal for thisTIF project was to redevelop the area into amixed-use, central city neighborhood, with bothcommercial and residential land uses.

Types of subsidies:Land assembly (land acquisition, land condem-nation, relocation subsidies for existing busi-nesses). Additionally, the city undertook severalinfrastructure improvements, including street-scaping, roadway construction, enhancement tomunicipal parks, extension of the streetcar sys-tem, and construction of an aerial tramway (agondola connecting a major university em-ployer’s facilities).

Revenue sources:Subsidies were financed using property taxes,city system development charges (for transporta-tion/parks improvements), and federal grants(streetcar).

Performance measures:Achievement of city policy goals (e.g., outputmeasures for job creation, number housing unitsand/or affordable housing units) and dollars ofprivate development (return on public investment).

Contact:Portland Development Commission


Jurisdiction: City of Evanston, Illinois

Goal:Prior to redevelopment, the district containedunderutilized parcels (e.g., surface parking) lo-cated on the western edge of the downtown busi-ness district. The goal for this multi-stage TIFproject was to a) create a joint venture researchpark between a leading Big Ten university andthe city and b) develop other parcels for parkinggarage, commercial (hotel, restaurant, entertain-ment, office), and residential land uses. The dis-trict is situated near a regional commuter trainline and light-rail train line that reaches the cen-tral city (Chicago).

Types of subsidies:Land assembly (land acquisition, land condem-nation, relocation subsidies for existing busi-nesses), construction of parking garage, operatingsubsidy for parking (discount for hotel guestsand moviegoers), and hotel property tax rebate(on a portion of the property taxes based on a for-mula of taxation per square foot).

Revenue sources:In addition to property tax increment, revenuessupporting TIF costs include sales taxes, hoteltaxes, amusement taxes (from newly constructedmovie theater), and parking revenues.

Performance measures:For the comprehensive annual financial reportand a state-mandated annual report, the citytracks incremental revenues and expenditures(inputs) on an annual and cumulative basis sincethe formation of the TIF. Additionally, it tracksprogress on TIF projects using measures such asleverage ratios (dollars of private investment di-vided by public investment dollars), annual EAVgrowth, and occupancy rates on office space andsales of condominium units, expressed as a per-cent of total available space.

Contact:City of Evanston Planning Division


Jurisdiction: City of Milwaukee, Wisconsin

Goal:Redevelop a strategic and visible center of busi-ness and entertainment in the heart of the city’sdowntown. Construction of a 940-space publicparking structure would in turn make possiblethe construction of a mixed-use private develop-ment (high-end residential condominiums,220,000 square feet of leased office space, andanother 24,000 square feet of ground floor retailspace). The public parking structure, owned bythe city, accommodates condominium tenants,employees, retail customers, as well as thepublic.

Types of subsidies:In-kind subsidy of parking garage construction

Revenue sources:Property tax and parking garage receipts

Performance measures:Performance measures were devised to answertwo questions. First, is the proposed projectlikely to be successful? To address this, the cityestimated the internal rate of return to the cityas well as the net present value over at leasttwenty to twenty-five years (beyond the expectedlife of the district). Second, is the proposed sub-sidy necessary to make the project happen? Thisinvolved assessing the expected private investorreturns to confirm that strictly private financingof the proposed public parking structure was notfinancially feasible.

This requires forecasting a cash-on-cash returnto the developer along with the proceeds fromthe ultimate sale of the private development tento twenty years after construction.

Contact:Redevelopment Authority of the City of Milwau-kee (RACM)


Jurisdiction: Village of Deerfield, Illinois

Goal:The TIF district was located on both sides of aplanned regional arterial road that was subse-quently built. The district had consisted ofvacant parcels, underutilized parcels, and non-polluted industrial uses. The goal was to rede-velop the area into mixed-uses, including of-fice-research and retail, which would becompatible with neighboring residential landuses.

Types of subsidies:Primarily infrastructure improvements—mod-ernization of the village-owned sewerage treat-ment plant; construction of a new collectorroadway (traffic levels between a regional arte-rial road and a residential street) with a gradecrossing of rail lines; extension of water andsewer mains; and reclamation of a non-hazardouswaste landfill. The latter resulted in the con-struction of a combined village/park district pub-lic works facility and adjacent park. In addition,TIF revenues contributed to the construction of anew senior center with additional privateresources.

Revenue sources:Property tax. Projects were financed with bondproceeds serviced by the TIF property tax incre-ment and subsequent additional incrementalproperty taxes.

Performance measures:Increase in assessed valuations. (Base propertyvaluation of $14 million in 1982 has grown toover $173 million in 2003 tax year. Over $107million in surplus revenue has been returned tothe local taxing districts and district was termi-nated early.)

Contact:Village of Deerfield, Finance Department


Resources

The International Economic DevelopmentCouncilAssociation representing state and local officialsand private-sector consultants involved in eco-nomic development.

http://www.iedconline.org/

The Illinois Tax Increment AssociationState association representing private-sector ad-visors and local governments using TIF as aneconomic development tool.

www.illinois-tif.com/

Civic FederationNon-partisan government research organizationperforming assessment of metropolitan Chicagogovernment programs, including an impact anal-ysis of city and suburban TIFs.

http://civicfed.org/articles/civicfed_134.pdf

National Association of RealtorsReport commissioned for national associationrepresenting real estate brokers.

http://www.realtor.org/SG3.nsf/Pages/TIFReport?OpenDocument

City of Minneapolis, MinnesotaFinancial policy governing use of TIF subsidies.

http://www.ci.minneapolis.mn.us/cped/tax_increment_policy.asp


Documents

An Elected Official's Guide to Tax Increment Financing