Tax-Incremental Financing and Downtown Columbia

Friday July 29, 2016

The Howard County government has recently proposed a tax-incremental financing (TIF) plan that would pay for certain amenities in downtown Columbia, including a parking garage. As usual, there are a great deal of discussion about this and whether or not a TIF is appropriate. Part of this focuses on how TIFs are used to improve blighted areas and no reasonable person could call downtown Columbia blighted. And downtown Columbia is not blighted.

But just because TIFs have historically been misused for economic development (also, so have port authorities), does not mean it is not the right answer, here. TIFs are very good at connecting the costs of capital-intensive public works with the principal beneficiaries of those works. All of this goes back to basic economic theory. Government is very good at providing public goods, those goods that where everyone benefits regardless of how others use the service. At the local level, the classic example is public safety through policing. And those are very appropriately paid for using general tax revenue.

However, not all publicly provided services benefit everyone equally. For instance, water and sewer services primarily benefits those with the connection. The pipe from the water main to, say, a residence, mostly benefits the residence, but it is owned by the service provider. The government, in this case. And the government service provider benefits from the service, as they get paid by the resident for services. This leads to a bit of a conflict on how funding should work. TIFs are actually a great way to resolve this conflict.

With a TIF, the government can borrow, through the bond market, funds for some capital works project. The borrowing is tax-advantaged, therefore the interest rate is a bit lower than others would pay. However, the bonds are not general obligation bonds, and are therefore not true obligations of the government. If the governmental unit walks away, it should not harm the overall financial condition (but I wouldn’t trust their next TIF!). A TIF district, covering some amount of land, is created, and a slice of the property taxes from this land goes to repay the bonds. This is where it gets interesting.

If a public works project is built in some area, there is a potential for an economic benefit to accrue to nearby property owners. For instance, if a nice park is built, property close to that park becomes more desirable, leading property prices to increase. This is a benefit that the property owners didn’t earn naturally, but they get it, and that’s okay. As the property prices increase, so do the associated property taxes. The difference between what those taxes were and are now is the tax increment. With a TIF, the tax increment is allocated to pay the special bonds. It’s a neat trick. After the bonds are paid, the tax increment can, but does not have to, revert to the general fund for treasury use.

Using a TIF is actually a reasonable way to pay for hyper-local amenities, such as utilities, a library, small parks, and parking garages. The local beneficiaries of those amenities are forced to pay for it. But as large projects, the capital outlay can also be amortized over the lifespan of the amenity, which is also preferable due to both the cost and concerns over intergenerational equity. The TIF becomes an almost perfect way to tie the finance of a project to its beneficiaries, both over space and time.

Now, there are some downsides. For some amenities, like a library, the beneficiaries are not entirely clear. More to the point, it is not self evident where the boundary is between who benefits and who does not. So drawing TIF districts is more art than science. Also, if the TIF district is not terminated after the end of the bonding period, it can become an unaccountable slush fund. However, these are specifics that can be quibbled over that do not change the overall utility of the financing form.

In the case of the TIF for downtown Columbia, there is room for improvement. There are certainly things I would change about how it is structured and some of the details. But the application of a TIF is absolutely the best and correct solution for downtown Columbia.

Image by Sue Brink / United States Navy / Wikimedia Commons.