Tax increment financing, or TIF, is a wildly popular economic development tool in the United States, but it often falls short of its promise to revitalize struggling neighborhoods. So concludes a new Lincoln Institute report that reviews how TIF programs have performed across the nation.

In Improving Tax Increment Financing (TIF) for Economic Development, University of Illinois at Chicago Professor David Merriman reviews more than 30 studies of TIF over several decades, concluding that “in most cases, TIF has not accomplished the goal of promoting economic development.”

The report explains the history and mechanics of TIF, details how several cities and regions are currently using the tool, and recommends how policy makers can improve TIF practices going forward.

“Tax increment financing has the potential to draw investment into long-neglected places, but its success requires rigorous analysis, transparency, and oversight to ensure that the expenditure of taxpayer dollars truly benefits the public,” Merriman said.

First implemented in the 1950s, TIF is a method of funding economic development in a designated area — a TIF district — by earmarking increases in future property tax revenues that result from increases in real estate values in the district. The tax revenue can be used for public infrastructure or to compensate private developers for their investments.

In theory, TIF generates new property tax revenue by spurring development that would not otherwise occur, which results in a larger tax base. The tool can help build trust and provide for a mutual commitment between local government and developers, and it can facilitate political support for investments by stipulating that taxpayers outside the TIF district will not have to contribute.

However, TIF is prone to several pitfalls. In practice, TIF often captures some revenues that would have been generated through normal appreciation in property values, even without the TIF-funded investment. This over-capture of revenue diverts resources away from public services citywide. Cities also sometimes exploit TIF to obtain revenues that would otherwise go to overlying government entities such as school districts.

In addition, TIF can make cities’ financial decisions less transparent by separating them from the normal budget process. In Chicago, for example, $660 million — nearly a third of the city’s property taxes — go to TIF districts, making public scrutiny of these funds more difficult and preventing elected officials from re-prioritizing the spending. Finally, TIF carries the same risks as other types of business tax incentives, which can lead to inter-city competition and short-term decision-making.

Merriman makes five recommendations to improve the performance of TIF:

• States should track and monitor TIF use. Most states already monitor property tax assessment and could easily report on the number of TIF districts and the changes in property values. Wisconsin and Illinois can serve as models for other states.
   
• States should allow counties, school districts, and other overlying local governments to opt out of TIF. This measure would reduce the incentive for cities to use TIF to capture revenues that otherwise would have gone to overlying governments.
   
• States should review their “but for” TIF requirements to determine whether they are effective. States sometimes require proof that a proposed TIF development would not occur “but for” the establishment of a TIF district, but the rules are often open to loose interpretation. A 2015 California law could serve as a model.
   
• Local governments should provide extensive, easily accessible information about TIF use, revenues, and expenditures. Greater transparency would help elected officials monitor and regulate the use of TIF.
   
• Researchers should study, document, and explain the different outcomes of TIF use in various geographic areas. To date, academic studies of TIF document mixed outcomes but do not clearly explain the causes of this variation.

“While further research is needed, there are clear steps cities and states can take now to improve the performance of TIF,” said Lincoln Institute Senior Fellow Joan Youngman, head of the Department of Valuation and Taxation. “In some cases, policy makers might opt to develop alternative tools for financing infrastructure, affordable housing, and economic development.”

This article was originally published on the At Lincoln House blog.

Photograph: Cortex Innovation Community

America’s second most valuable public company, Amazon has grown across multiple industries over the years and is planning a second headquarters. The company has cited incentives, such as tax credits and reduced-price land, as a key factor in selecting a host city. Daphne Kenyon, an economist and fellow at the Lincoln Institute, and coauthor of the Policy Focus Report Rethinking Property Tax Incentives for Business , has shared her insights into what Amazon’s second headquarters could mean for the Boston area – one of 20 finalists in the competition to host Amazon. What follows is an edited interview by David Franco, a Lincoln Institute intern in spring 2018.

David Franco: How would the location of HQ2 in Boston impact the city?

Daphne Kenyon: Despite Amazon’s claim that HQ2 would bring 50,000 jobs and $5 billion in investment, it is not clear that having HQ2 in Boston would be a net benefit for the citizens of Boston. Housing is already expensive in Boston, and such an influx of new employees could further drive up the cost of housing, for example. Also, if the city of Boston gave up too much in taxes and other financial incentives, the negatives of HQ2 could outweigh the positives.

DF: What factors should a city like Boston consider when deciding whether and how to provide tax incentives to a business like Amazon?

DK: As a matter of good practice, before promising tax incentives a city should systematically weigh the benefits and costs of attracting the headquarters. Our report (p. 49) sets out a benefit-cost framework that reminds policy makers to consider the effects of any potential tax incentive deal on the city’s finances, labor market, local economy, and quality of life. In some cases, the costs of attracting a firm outweigh the benefits. This can be summed up by the phrase: “when winners end up losers.”

One way to characterize the results of a benefit cost analysis is by stating the findings in terms of the cost per job gained. Certainly, attracting a business when the cost per job gained is $10,000 looks much better than when the cost per job gained is $1 million.

DF: Based on your research, how important are tax incentives to a company’s choice of where to relocate? What other factors would they consider?

DK: We found tax incentives are not the most important factor in determining business location. Companies consider a host of factors including traffic, climate, and, most importantly, characteristics of the local labor market. This includes wages, skills, and the availability of workers. Certainly, as home to more colleges and universities than any other city in the United States, Boston stands out in that regard.

DF: What other costs should cities consider when a large employer relocates?

DK: Cities need to think about the cost of infrastructure. Does the city have adequate infrastructure for the additional workers or will improvements to infrastructure impose big costs on the city? Boston has an aging, poorly maintained public transit system. That system already needs upgrades, but renovations would be even more important and urgent if Amazon brings its second headquarters to Boston. Another cost of playing the incentive game is that other businesses may request or expect such incentive packages in the future.

Seattle’s recent failed efforts to impose a head tax on Amazon and other large employers raises another red flag. Does Boston want a single employer to be so important to the city that it has outsize influence over political decisions?

DF: How do Boston’s tax incentives compare to those of the other finalists in the competition?

DK: We don’t know specifically what Boston or other cities are offering. This competition has not been very transparent. At least two cities — Toronto and Austin — have said they are not offering a tax incentive package. Columbus, Ohio, revealed its local tax incentive package, but we don’t know what Jobs Ohio, the state development agency, is offering. We will likely know about the tax incentives offered by the winning city, but might never know what the other finalists offered.

This article was originally posted on the At Lincoln House blog.

Photo by kiewic / Flickr CC BY 2.0