Review of “Can Tax Increment Financing Support Transport Investment”

Needs to be supplemented by other forms of financing

Here I try to read the report authored by Murtaza Haider and Liam Donaldson on Can Tax Increment Financing Support Transportation Infrastructure Investment? I had been procrastinating doing it for some time but then Toronto Mayor suggested using road toll to rehabilitate Gardiner Expressway and it kind of jolted me to write this review down.

The paper mainly reviews the literature and case studies of Tax Increment Financing (TIF) but though not much attention has been given to Land Value Capture (LVC), author appear to prefer LVC over TIF.

What is TIF and LVC?

In Principles of Political Economy (1848: 219–220), John Stuart Mill establishes the case for why instruments such as land value capture should be considered for the larger public good. Suppose that there is a kind of income which constantly tends to increase, without any exertion or sacrifice on the part of the owners: those owners constituting a class in the community, whom the natural course of things progressively enriches, consistently with complete passiveness on their own part. In such a case, it would be no violation of the principles on which private property is grounded, if the state should appropriate this increase of wealth, or part of it, as it arises. This would not properly be taking anything from anybody; it would merely be applying an accession of wealth, created by circumstances, to the benefit of society, instead of allowing it to become an unearned appendage to the riches of a particular class. When land values improve as a direct result of new public-sector investments in an area, a tax can be imposed on the incremental increase in land value in addition to the tax on the base land value. The principle behind LVC is that the increase in land values is the result of investments by the public sector. The state is therefore justified in claiming a share in the increased land value. We illustrate this with an example from Walters (2012). Assume that the base-year value for a large parcel of land is $420 million. Each year, the value of the land appreciates, so that the current-year land value is $441 million or 5 percent higher than it was in the base year. A 1 percent tax on the base land value of $420 million will generate $4.2 million in property taxes. A 40 percent tax on the incremental land value increase of $21 million (the difference between $441 and $420 million) will generate another $8.4 million. Thus, the total tax using LVC will be the sum of $4.2 million and $8.4 million, or $12.6 million. TIF is a type of value capture that was originally conceived as a funding mechanism to help rehabilitate distressed urban areas. TIF works on the principle that infrastructure and public-space improvements usually attract private investment and stimulate development, resulting in an increase in property taxes that could contribute to the capital cost of such interventions (Carroll, 2008). A municipality initiates a TIF agreement by designating a specific geographic area as a Tax Increment Financing District (TID). Before TIF designation, overlapping taxing jurisdictions collect property taxes in the area. Once a TID is established, property taxes are frozen at a base rate, which coincides with the total property valuation in the area at the time of designation (Smith, 2009). While the TID is active, taxing authorities continue to collect property taxes at the base assessment value, while the municipality issues general obligation or revenue bonds to pay for improvements within the area such as land acquisition, streetscape enhancements, or water and sewer lines (Byrne, 2010).

As land and properties are developed, the assessed value of properties in the TID increases, creating an incremental increase in property tax revenue above the base value. The municipality uses this increase, which is equal to the total property tax assessment of the TID minus the base assessment value, to pay off the bonds that funded the improvements (Merriman, Skidmore, and Kashian, 2011). When the TIF agreement expires and the debt is repaid, all property tax revenue (base and incremental) will once again be collected by all overlapping taxing jurisdictions at the new, higher level (Byrne, 2010). Figure 1 illustrates this process.

TIF differs from a one-time LVC levy in one fundamental way. While TIF provides a reasonably reliable and steady stream of funding over the course of several years or even decades, other forms of value capture, especially LVC, are designed to capture benefits only from the one-time gain in land values associated with the decision to locate improvements in and around the development in question. Because of this one-time gain, revenues from a one-time LVC levy are not viewed as sustainable over the long term (AECOM, 2012).

Review of Literature and authors’ conclusion

The authors subsequently go on to review the literature about TIF and conclude the following:

The studies reviewed here highlight several possible shortcomings in implementing TIF.

1. Since TIF revenue largely relies on an increase in property values over time, the assessed values in the base year matter to the future revenue-generating abilities of TIF. When TIF is used in distressed neighbourhoods, where property values are low in the base year, TIF investments essentially provide the impetus for the growth in property values over time (Lester, 2014). But when TIF is used in non-distressed districts, where property values are not as low relative to the rest of the city, the increase in property values in TIF districts is more limited.

2. Another related concern is the timing of TIF implementation relative to the business cycle. TIF projects launched during or at the onset of an economic recession are unlikely to experience a strong increase in property values. Since the success of TIF depends upon an aggregate increase in property value.

3. The type of proposed land use change also has a bearing on the success of TIF. Several projects reviewed earlier suggest that single-purpose land use developments, such as industrial or commercial, did not result in higher appreciation of property values or growth rates. Repeatedly, it was found that mixed-use developments that allowed for new residential developments in combination with other land uses were more likely to be successful in meeting the intended objectives (Bhatta, 2003; Carroll, 2005)

4. The property tax regime is also important. TIF is structured such that property taxes imposed on increases in assessed values are used to pay back the funds borrowed to build new infrastructure. The local municipalities charge property tax on the assessed value of the property, which remains frozen at the base-year level until TIF is in place. If property tax rates are not raised over time, or provisions are not made for an increase in property tax revenue commensurate with inflation, the funds available for regular municipal expenses, such as policing, schools, water supply, waste disposal, and parks management remain fixed at the base-year levels. This makes TIF a zero-sum game, because TIF essentially takes away funds from other public uses (Fisher, 2011).

5. Finally, TIF is also known to contribute to the gentrification of neighbourhoods (Weber, 2007). The increase in residential property values could create housing affordability challenges for low-income households living in formerly distressed neighbourhoods. Unless TIF investments provide for new affordable housing as part of development, housing affordability could worsen for very low-income households.

Though I don’t disagree with the authors but what aforementioned highlights is that TIF is not a one size fits all solution. But then, when it comes to public policy matters, nothing is.

However, what author’s fail to mention above is that how does LVC overcome these challenges or is their a better revenue capture mechanism. I believe that LVC faces the same challenger plus in addition to above, where increased tax on the increased value of the property is payable annually, LVC can only be captured it the current owner decides to sell the property to the next buyer. If no sales transactions occur, there will be zero LVC captured whereas in case of TIF, increased property tax continues to be collected annually.

Shepperd Corridor Study

Though whereas author’s were keen to point out that there can be selection biases when selecting TIF for projects, for their own hypothetical case study, they couldn’t hide their bias as they carry out a speculative exercise where it is sure to show its inefficacy. It is also obvious from the fact that Prof Murtaza can’t help and take swipe at Mel Lastman though it has nothing to do with the matter at hand. Anyway, the hypothetical case study is concluded as follows:

The Sheppard East subway extension cost approximately $1 billion to build or $2 billion in 2016 dollars. The TIF revenue generated from the new residential development in the corridor at a net present value of $173 million is less than 10 percent of the capital cost of the Sheppard East subway extension (in 2016 dollars). Given that the TIF revenue has been raised from 3,358 properties, one could argue that higher amounts could be generated if the TIF were applied to all properties along the corridor. We ran a simulation to collect TIF revenue from the entire housing stock in the corridor. The Net Present Value of TIF revenue generated from 15,226 units equaled $785 million. While we see a significant increase in the TIF revenue in the revised simulation, even when the TIF revenue is spread over more than 15,000 housing units, it generates less than 50 percent of the capital costs for the Sheppard East subway extension (in 2016 dollars). Furthermore, for the entire time that TIF is in effect, the municipal services provided to the community of over 15,000 households will be based on the property taxes frozen, or allowed to increase at the rate of inflation, at the base-year level. This could lead to service shortfalls, since any increase in assessed values does not contribute to higher property tax revenue for municipal services.


And they conclude it by saying the following:

The key takeaway for municipal governments in Canada interested in deploying TIF to support infrastructure development is to realize that TIF could support only partial capital costs of such a project. Municipalities could also implement a one-time LVC levy to share in the land value appreciation resulting from public-sector investments in infrastructure developments. In addition, economic cycles have the potential to affect the expected increase in property values, which in some instances would result in lower-than-expected TIF revenue. Lastly, Canadian municipal authorities should consider TIF mainly for small-scale projects rather than large projects on the scale of a subway.

What is surprising in all of this that without reviewing any literature on LVC nor doing any analysis of LVC except for describing that it is a one time levy, author’s continue to promote it over TIF. At least, with TIF we know the nature of the beast and can try to tackle its shortcoming when implement it. With respect to LVC, do we just take the words of authors?

But moreover, authors’ fail to propose a better solution to fund transport infrastructure. They could’ve recommended a Japanese bullet train style model which seems to work very well in Japan. Again it is not a perfect solution as the demographic, geographical, transport patterns etc may differ between Tokyo and GTA but it is some to think about. From The Economist

In 1987 Japan’s national railways were divided and privatised into seven for-profit companies. JR East, the largest by passenger numbers, does not require any public subsidy from the Japanese government, unlike the heavily subsidised French network. One reason for its efficiency is that JR East owns all the infrastructure on the route — the stations, the rolling stock and the tracks — meaning there are fewer management teams duplicating each other’s work. (By contrast in Britain, for instance, ownership of the tracks and trains is split up.) But the railway also thrives because of a planning system that encourages the building of commercial developments and housing alongside the railway route. JR East owns the land around the railways and lets it out; nearly a third of its revenue comes from shopping malls, blocks of offices, flats and the like. This money is reinvested in the network.

The ability to build large developments alongside the high-speed railways is a boon to the Japanese bullet line, as is the ability to charge high ticket prices. (When Koichi Tanaka, a scientist, won the Nobel Prize in 2002 he was reported as saying he would use the money to buy a ticket on the Shinkansen, to loud cheers.) But even so, 71% of the revenue from passenger tickets at JR East comes from the conventional, slower railway.

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