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Tax Increment Financing: The Basics

Tax increment financing (TIF) is a tool used by municipal governments to stimulate economic development in a targeted geographical area. TIFs are used to finance redevelopment projects or other investments using the anticipation of future tax revenue resulting from new development. When a TIF district is established, the “base” amount of fproperty tax revenue is recorded using the status quo before improvements. To the extent such efforts are successful, property values rise, leading to an increase in actual property tax receipts above the base. While the base amount of property tax revenue (the level before redevelopment investments) continues to fund city services, the increase in tax revenue is used to pay bonds and reimburse investors and is often captured as city revenue and allocated toward other projects. 

Alternatively, municipalities can issue bonds, backed by the expected TIF revenue, in which case the TIF proceeds are used to pay back the bonds. The incremental increase in sales taxes in the district can also be either captured by the district as revenue or used to pay back the bonds. The lifespan of most TIF districts typically range from 20 to 30 years—enough time for incremental property tax increases (due to increases in assessed property values) to pay off the initial improvements.

TIF offers a strategy for municipalities to “self-finance” a redevelopment project without having to raise or impose new taxes. A TIF is often one of the only options for municipalities that generate revenue for affordable housing through real estate transfer taxes or rely on low-income housing tax credits to finance new development projects in targeted neighborhoods. Moreover, once the TIF district expires, the municipality will receive the full benefit of the property taxes on a much higher property tax base than would otherwise have been present without the investments.

Although guidelines vary in the states that have laws regulating TIF activity, there are similarities across jurisdictions. Most states require that a TIF be targeted in areas of economic or physical distress and that any improvements to the district as part of the program serve the public interest. In areas that do not conform to these conditions, some local governments also have authority to establish TIFs by determining that a development project would not have been financed “but for” the presence of the TIF.

For example, in Madison, Wisc., TIFs can only be used if the proposed development would not occur “but for” city assistance. The “but for” option can be beneficial to jurisdictions that do not meet other state TIF criteria. TIF critics, however, argue that such loose criteria for using TIF enables governments to divert needed tax revenue to subsidize projects that are not always vital to the public interest, such as golf courses, hotels or big-box stores.

Since TIF operates within a set district, it is well suited for jurisdictions that have specific neighborhoods in need of redevelopment or large tracts of land to be developed. TIF can be used in the rehabilitation of older communities and the reconfiguration of buildings such as mills and factories for housing, as well as to fund new development.

Alternatives to TIF

Some creative value capture mechanisms similar to TIF are being used in non-blighted communities to fund transit projects or transit-oriented development. These present unique opportunities to preserve or expand affordable housing near transit and other amenities where housing values are expected to rise, relieving some of the gentrification pressures and reducing the risk of displacement. 

In 2004, the Pennsylvania Legislature passed the Pennsylvania Transportation Revitalization Investment District (TRID) Act, which enables municipalities to designate defined areas around public transit nodes as Transportation Revitalization Investment Districts (TRIDs). 

The purpose of the TRID is to encourage mixed-use development and leverage community revitalization efforts to boost local transit ridership. Like tax increment financing, TRIDs capture the value of the real estate tax increment from new development occurring within the district, and proceeds can used for site improvements and maintenance or for transportation capital improvements. Communities considering this model may want to require a specified share of the TRID funds to be spent on affordable housing within the TOD.

In 2008, the City of San Francisco considered the use of Infrastructure Financing Districts (IFDs), a financing tool approved by the state to pay for capital improvements, including transit investments, to help finance the redevelopment of five neighborhoods included in its Eastern Neighborhoods Area Plan. IFDs differ from TIFs in that they do not require that an area be blighted, they do not have to be contiguous areas of land and they are not are not limited to spending all the tax-increment revenue within the boundaries of the district (although a portion is required to go back to the district). According to California state law, 20 percent of the tax increment raised through an IFD must be used for affordable housing in the event that existing homes are demolished or removed as a result of the public infrastructure being financed by the IFD. In 2011, the Rincon Hill Infrastructure Financing District (RHIFD) became the first pilot IFD program in San Francisco. It was formed by the owners of 9 different large, vacant properties in partnership with the City.

Issues to consider when creating a TIF district

Prior to implementation, the use of TIF requires careful consideration through feasibility studies, a strong development plan, public hearings and stakeholder partnerships to support a development strategy. Creation of a TIF district needs to be approved by local elected officials and generally needs public support. Such planning can help reduce the likelihood that TIFs fail to generate sufficient increases in property values to pay back the municipality for the initial improvements. Advance planning also can help jurisdictions put into place affordable housing policies that ensure that a mix of affordable housing options is preserved even as property values rise from successful redevelopment efforts.

Beyond the need for careful planning, TIFs can be controversial for two reasons. One debate about the use of TIF is whether some or all of the tax increment captured by TIFs would have been generated anyway, without the public’s investment. If so, critics argue that TIFs do not really represent “new” incremental tax dollars, but rather the diversion of existing tax streams for new purposes. Research suggests that a variety of variables, including land use, location, size of a tax increment district and area economics create different outcomes in municipalities that use TIF, and will play a role in the tax revenue increase for a jurisdiction. 

A study by the Neighborhood Capital Budget Group examined 36 TIF districts in Chicago, Ill., and concluded that when TIFs are targeted at areas with declining property values, new public improvements and developer subsidies do help attract new businesses and industries to unused or under-used land, add jobs and grow the tax base. However, when TIFs are established in areas already increasing in value, the “natural growth” of the property tax revenue is captured by the TIF district and diverted away from other public priorities—such as education and safety—toward economic development. This analysis suggests that TIFs are most cost effective when adopted in areas with declining property values. However, housing TIFs can still be a smart strategy in areas with rising property values by providing funding that helps preserve the availability of affordable homes for existing residents as property values rise.

In 2009, the Public Policy Forum published the study Too Much or Not Enough?, the findings of which suggest that mid-size cities in Wisconsin are overusing TIFs because of broad interpretation of the “but-for” test and “blight” requirements.  Specifically, it found that the number of municipalities using TIFs had grown by 400 percent since 1990 and in many cases had been implemented in areas already experiencing economic growth.   Overuse of TIFs could be problematic by potentially over-leveraging the anticipated tax revenue, especially in smaller jurisdictions.  Based on modeling and analysis, the report also found significant regional impacts of TIF use.  A 10-percent increase in increment value in the suburbs would result in a 1.1-percent decrease in central city property values by creating an artificial market to attract development away from central cities, thus depressing property values in center cities.   The report concludes that TIF designation should be stricter to prevent overuse and that there should be greater oversight of TIFs to reduce potential negative regional impacts.

A second concern sometimes raised with TIFs is that if they succeed, they will spark gentrification and displacement of lower-income residents. Housing advocates in Chicago have been critical of the city’s use of TIF funds for this very reason.  According to one report, only four percent of TIF funds generated between 1995 and 2007 were targeted to affordable housing development. One major way to address this concern is to ensure that a minimum percentage of TIF revenue is used to preserve and expand the availability of affordable homes. Sound planning is also essential to ensure that land is purchased within the district for affordable homes before it becomes too expensive.

To the extent a TIF is successful in revitalizing neighborhoods and increasing property values, existing properties will become less affordable in the TIF district in the long run—both because of rising property taxes for existing homeowners and because the TIF motivates existing property owners to improve and/or sell their properties to owners interested in building more expensive homes. While this economic development is precisely why TIF was established in the first place, it is important that communities preserve ongoing affordability in the face of increasing property values.

Key Resources

Websites

How TIF Works: Basic Mechanics. Prepared by the Minnesota House of Representatives Research Department. 

TIF Case Studies.  Prepared by the Corporation of Development Finance Agencies.  

Articles & Reports

Tax Increment Financing: Tweaking TIF for the 12st Century. 2014. By Sarah Jo Peterson. Urban Land Institute.

Tax Increment Financing Case Studies: How Cities and States Use Tax Increment Financing to Develop & Preserve Affordable Housing in their Communities. 2011.  By Katie Falgoust and Kelly Weiss.  Austin, TX: PeopleTrust.

Using Tax Increment Financing for Brownfields Redevelopment. 2007. By Evans Paull. Northeast-Midwest Economic Review. Washington, DC: Northeast-Midwest Institute. 

Keeping the Neighborhood Affordable: A Handbook of Housing Strategies for Gentrifying Areas. 2006. By Diane Levy, Jennifer Comey and Sandra Padilla. Washington, DC: Urban Institute. 

Tax Increment Financing: A Tool for Local Economic Development. 2006. By Richard Dye and David Merriman. Land Lines, Vol. 28, no. 1. Lincoln Institute of Land Policy. 

Tax Increment Financing in New Orleans. 2003. New Orleans, LA: Bureau of Governmental Research.

Straying from Good Intentions: How States are Weakening Enterprise Zone and Tax Increment Financing Programs. 2003. By Alyssa Talanker and Kate Davis. Good Jobs First.

The State Role in Urban Redevelopment. 2003. Prepared by Nancey Green Leigh (Georgia Institute of Technology) for the Brookings Institution Center on Urban and Metropolitan Policy and CEOs for Cities.

Protecting Public Education from Tax Giveaways to Corporations: Property Tax Abatements, Tax Increment Financing, and Funding for Schools. 2003. National Education Association.

Do Tax Increment Finance Districts in Iowa Spur Regional Economic and Demographic Growth? 2002. By David Swenson and Liesl Eathington. Iowa State University Department of Economics.

Tax Increment Financing. 2002. Prepared for the National Association of Realtors by Craig L. Johnson (Indiana University School of Public and Environmental Affairs: Bloomington, IN) and Robinson and Cole Law Firm (Boston, MA).

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