By Duke Dennis
Overview: What is a TIF?
Tax Increment Financing (TIF) is a form of subsidy offered by municipalities to encourage and support private development and redevelopment by reducing the cost of the development, thus making it cheaper and easier for the developer to complete the project. This form of public financing is regularly used to encourage new development along city growth paths, development of blighted areas, and cleanup of contaminated areas (i.e. brownfields). The first TIF was created in California in 1952; since then, TIF legislation has made its way to 49 of the 50 United States with the only exception being Arizona. TIFs are a popular form of public financing because they do not unnecessarily burden tax payers and they do not disrupt taxes currently received by existing entities.
How do TIFs work?
Once a TIF is approved by the municipality governing the site, the municipality will create a TIF district that encompasses a defined area; within this district is the project to be built or redeveloped. The TIF district designation is typically in place for a defined period of time, usually between 20 to 30 years, but it can vary.
Before we get into the math behind TIFs, let’s have a quick lesson on how property taxes are determined. Counties are responsible for assessing property values (called assessed values) for taxing purposes. Within counties are multiple taxing entities, such as your school district, fire department, local hospitals, etc., all of which assess and collect taxes on your property to support their services. Each taxing entity has its own tax rate that is multiplied by the county’s assessed value to determine the taxes owed. When a TIF is created, it will not disrupt the tax revenues being collected by these local agencies (schools, fire department, hospital, etc.) because of the cap or base assessed value component of a TIF.
For properties within the TIF district, a cap or base assessed value is given (depicted below by the blue box), and going forward, any increases in assessed value above that established by the cap are called “incremental assessed value.” The resulting tax revenues from the incremental assessed value go towards subsidizing the new development. After the tax revenues have returned the amount of the subsidy or after the TIF expires, the TIF district will be extinguished and taxing entities will receive the now higher tax revenues, which are based on the base assessed value plus the incremental assessed value (depicted below by the yellow polygon). Below are two graphics detailing the basic concept and the math behind TIFs.
The theory is that, as a result of the new development, property values will rise in the surrounding area (i.e. the defined TIF district). You can see the assessed property value increase being depicted by the red triangle in the graph above. As property values rise, so do the tax revenues realized. This way, the properties in the TIF district that receive the benefit of the new development shoulder the burden of the cost of subsidizing the development, and property owners outside the TIF district do not pay for public improvements that will not affect their property value.
What developers need to know about TIFs:
- First and foremost, TIFs reduce what the developer pays for the development by providing a capital infusion and reducing the amount of equity the developer must bring to the table.
- Lenders view TIF funds as equity in a deal. This can act to de-lever a transaction, which can lead to better financing terms. At the same time, borrowers must be cognizant of recent bank regulatory changes (i.e. Basel III) that limit how much TIF funding can be counted as equity.
- TIFs are a taxpayer-friendly form of financing; thus, it is easier to get public support for a development when using a TIF as the form of public financing as opposed to issuing bonds or raising taxes.
- It is not uncommon that a developer receiving TIF funds must include certain agreed upon public improvements. An example would be that the development must include new sidewalks, streets or other infrastructure that the city negotiates with the developer.
Any developer considering a new project should look into TIF incentives that may be available through the municipality that governs their site. As highlighted above, any TIF funds received could go towards reducing the developer’s personal equity requirements, gaining public support, and making the project more easily financeable (again, subject to Basel III).
- Craig L. Johnson, Indiana University (TIF Assessed Value Over Project Life – Graphic)