Galveston Economic Report
David Stanowski Publisher
The Truth About TIRZs
by David Stanowski
05 August 2009
What is a TIRZ?
A Tax-Increment Reinvestment Zone is a financing vehicle that allows a city to use the increased property tax generated by development to pay the infrastructure costs of residential, commercial, industrial, or mixed-use projects. Although originally intended for the development of blighted areas, that could not attract investment without some kind of subsidy, in recent years they are being used by any developer who has the necessary political connections to "push one through", and are targeted primarily at upscale projects that offer more opportunity for profit than blighted areas.
This article will present a variety of evidence and arguments that will demonstrate that TIRZs are bad public policy, for the simple reason that they represent a blatant form of institutionalized favoritism or cronyism towards select developers that cost taxpayers far more than any promised or actual benefits derived. The specific problems to be examined are:
The truth about TIRZs may shock you!
After wading through all of the complexity, and dealing with the lack of transparency intentionally built into TIRZs and RDAs, it eventually becomes clear that this is simply a financing technique for development infrastructure where the developer receives better terms than the municipality normally offers! In other words, a TIRZ is a financing scheme that is designed to be a benefit developers; NOT taxpayers. Cities try to justify their use by arguing that adding property to the tax base is good for the taxpayers, and the project seeking a TIRZ would not take place without this concession. However, they ignore the fact that the costs associated with development begin immediately while the taxpayers do not enjoy the benefit of new property taxes for 30-40 years. Many promoters make the claim, after a TIRZ project is under way, that "a new swath of high-value property is now on the tax rolls". The financing scheme is so complex that most people don't seem to realize that their claim is not true!
Since WWII, this country has been on a headlong quest for "growth", much of it misdirected into unneeded residential and commercial real estate, at the expense of the industrial manufacturing sector. The federal government has facilitated this misdirected "growth" by creating programs like FHA, Ginnie Mae, Fannie Mae, and Freddie Mac that subsidize and guarantee the loans of the buyers of these properties.
The whole orgy of debt expansion really began to kick into high gear about 2002 with the creation of the new financing schemes on Wall Street that securitized the debt from residential and commercial development so that it could be re-packaged and sold to unsuspecting investors as "low-risk investments". These new financing vehicles helped to create the worldwide housing bubble, and subsequent bust. To put Tax-Increment Financing in its proper perspective, it is necessary to recognize that it is just another one of many recent schemes that have brought this country to the brink of financial ruin.
Any pitch that includes "getting something for nothing" should always raise a red flag to anyone still possessed by any common sense, but the temptation to believe the high-powered "experts" with slick Powerpoint presentations suggesting just the opposite is often too persuasive for many to resist.
Kevin Depew illustrates this phenomena, as it effects the entire U.S. monetary system, but the same concept holds true for a specific program like Tax-Increment Financing:
"If a toothless meth head, at the bus terminal, offers to give you a piece of strange paper in exchange for your watch, it's called Theft by Deception. But if someone in a fancy stone building gives 250 million people some strange paper and says it's Okay to exchange it for watches and anything else people feel like parting with then it's game on. Why would people do this? For the same reason otherwise smart and worldly people fall victim to confidence games thousands of times a day all over the world: we want to believe."
"... the probabilities that billions of people could come together and agree to accept dollar bills backed by the promise of a handful of academics and pseudo bankers are so staggering that only a fool would attempt to perpetrate this grift on another human being."
What Kevin's commentary means to the taxpayers of Galveston is that when the slick consultants descend on the City to "explain" the benefits of TIRZs to them, it is no different than when a crackhead, on the Strand, approaches them to "explain" why he needs five dollars to put gas in his car. Don't let the superficial differences between these consultants, and the local crackheads fool you. You should be equally suspicious and skeptical, because they are both trying to get you to give them your money by merely convincing you to believe a story!
The Roman orator and statesman Marcus Tullius Cicero attributed the expression "Cui bono?" to Lucius Cassius, who the Roman people regarded as a very honest and wise judge. Cassius was in the habit of asking, time and again, "Cui bono?"; i.e. "To whose benefit?"
"This Latin adage is used either to suggest a hidden motive or to indicate that the party responsible for something may not be who it appears at first to be. With respect to motive, a public works project which is purported to benefit the city may have been initiated rather to benefit a favored campaign contributor with a lucrative contract.
Commonly the phrase is used to suggest that the person or people guilty of committing a crime may be found among those who have something to gain, chiefly with an eye toward financial gain. The party that benefits may not always be obvious or may have successfully diverted attention to a scapegoat, for example." Wikipedia
To really understand what drives the TIRZ process, the reader needs to ask, "Cui bono?" to help clarify what each party has to gain from it. The modern counterpart to this ancient Roman expression is, "Follow the Money!"
Funding the Infrastructure for Development:
Putting aside any quality-of-life or environmental arguments, for the moment, it is fairly well settled that developing real estate is a net plus for city governments; in the long run. Whatever infrastructure costs a municipal government must bear in the start up phase are eventually offset by increased property and sales taxes, which means that if they have the capital, they are well advised to provide what is needed. Up until the 1960s, many cities were in a position to do just that using their cash reserves, or by selling muni bonds. Since then, the financial position of municipalities has deteriorated rapidly due to their bloated payrolls and benefit packages, and increased spending on social programs.
Now days, when city governments want to reap the long-term benefit from development, they must first decide whether they are willing to pay for the new infrastructure, or simply make the developer shoulder the expense through impact fees.
If impact fees are calculated properly and fairly to include the full cost for infrastructure, i.e. debt service, as well as operating, maintenance, and construction costs, and to exclude anything not directly linked to the development, they avoid the problem of forcing existing residents to subsidize public services for new residents. In some locations, impact fees are set at outrageous levels to block growth, and not to assess the cost of new development.
Developers normally end up passing along the cost of impact fees to buyers, which raises prices, but at least they have every incentive to keep infrastructure costs to a minimum. If they want to include upgrades, they have to increase prices further, or settle for less profit.
Some argue that impact fees are totally unfair, because residents aren't assessed a lump sum cost to pay for the streets and sewers in existing neighborhoods, but in cities like Galveston, there is a marked difference between the quality of the pavement along 23rd street, between Broadway and Harborside, and the streets in Beachtown. It is true that existing areas of town escape impact fees, but they also have a much older and less functional infrastructure. If the impact fee is calculated in a reasonable manner, it should just about cover that difference.
If a city wants to finance the infrastructure, to encourage development, but doesn't have the necessary capital to do so, it can leave it scrambling for new financing ideas, that may not be in the best interests of the taxpayers! The straightforward way to raise money would be to sell muni-bonds. Unfortunately, in many communities, the voters must approve these bond issues, and often vote them down, because they do not share the same sentiment towards growth as their city government.
If muni-bond financing won't pass muster with the voters, another alternative might be to forgive or abate the property taxes on the project over the start up period. The taxpayers would lose the property tax from this project for several years, but after that, they would benefit from the increased revenue. This alternative is also not too popular with the voters, so more complex and unsavory schemes were needed that do not require voter approval.
Normally, TIRZs can be set up, and RDAs can sell bonds without voter approval, so they are a clever vehicle to use in areas where voters are not sold on growth. Unlike non-TIRZ projects, where a fixed amount is allocated to pay for the infrastructure, TIRZs allow their TIRZ boards to reimburse developers for just about any costs they deem proper, as the project evolves. This gives developers, who often control their own TIRZ boards, the opportunity to upgrade their infrastructure far beyond what would be paid for in a non-TIRZ project. Hundreds of palm trees, pavers, dune walks, concrete streets (as opposed to black top), and recreation facilities can be paid for by the Increment, allowing the developers to raise their prices, and increase their profits, due to these upgrades. The incentives are just the opposite to those in an impact-fee development; they favor the developers as opposed to the taxpayers.
How do TIRZs work?
Developers target an undeveloped or underdeveloped piece of property, and then lobby the city government for a TIRZ. If it's granted, they receive the additional property tax that the City collects that is due to the increased value from development, to pay the costs of the infrastructure. This property tax that they receive is known as the Increment. The developer receives the Increment from day one, while the taxpayers wait for the TIRZ to terminate, typically in 20-40 years, to receive any of the increased taxes.
Taxpayers in some cities have gotten wise to the fact that TIRZs offer little or no benefit to the public, and they have begun to organize opposition. In Houston, meetings opposing TIRZs have had turnouts of 200 to 1,200 people, and in Chicago a watchdog group called the Neighborhood Capital Budget Group was formed to monitor and resist further TIRZ formation.
The NCBG studied 36 of Chicago's 114 TIRZs and found that "Over the lifetime of the 36 districts that NCBG analyzed, the local taxing bodies that draw on Chicago’s property tax base will lose $1.3 billion in tax revenues they would have probably collected if these areas had not been declared TIF districts." Likewise, in 1999, the Houston Press estimated that Houston's then-existing TIRZs would force taxpayers to forgo nearly $2 billion in lost property tax revenue over the next 30 years.
It was only a matter of time before some government watchdog group decided to bring suit to have a TIRZ unwound:
"For years I've been calling on residents to rise up against our city's tax increment financing program, which siphons hundreds of millions of dollars in property taxes each year into accounts controlled by Mayor Daley.
Well, last week a group of residents in Uptown did just that. "Fix Wilson Yard", as the group calls itself, filed a lawsuit in Cook County Circuit Court to dismantle the long-controversial Wilson Yard TIF and turn over the roughly $28 million it's already collected to the Park District, public schools, and other governmental entities."
"But so what? The suit hits the TIF program where it's most vulnerable. It says the TIF is illegal because the area is not really blighted and would have been developed even without it—a criticism that could also be leveled at all the TIFs in and around the Loop. It accuses the city of breaking the rules governing the creation of a TIF. It says the TIF "will cost the city, its taxpayers and other taxing districts, such as the Chicago Public Schools, untold millions of dollars in lost tax revenues." It requests that the TIF be declared null and void."
"But the city has to take this lawsuit seriously. If the residents in Uptown prevail, their success will encourage other lawsuits against other TIFs—or, at the very least, keep the city from creating new ones."
The Chicago Reader
The Chicago TIRZs are making a big contribution to the City's current budget deficit: Chicago Budget Deficit to Exceed $500 Million
City of Chicago TIF revenues
When TIRZs Fail:
Robert Silvers was awarded Houston's first TIRZ, St. George Place, on 12 December 1990. This TIRZ would allow Silvers to pay for the infrastructure with the Increment, and by February 2011, the TIRZ would dissolve, and the taxpayers would reap the harvest of the additional property taxes that had been used by the TIRZ for 20 years.
"Earlier this month City Council quietly agreed to refinance the 1992 bond issue, thereby extending the debt for another 20 years and delaying until 2031 the additional property tax revenues the city will receive from St. George Place. Moreover, Council also approved $5 million in certificates of obligation on behalf of the TIRZ -- debt backed not by future property tax revenues but by the full faith and credit of the city's general fund. Council also committed another $1.1 million of its own money to the project.
The additional spending reflects the failed expectations of St. George Place, which has been marred by numerous delays, disputes over control of the land, the slow pace of lot sales and a lawsuit. From a financial standpoint, though, the problem is simple: The revenues generated by the TIRZ have not been sufficient to support the debt issued in 1992."
If Galveston TIRZs are not able to pay off their infrastructure costs by their end dates, it is likely that the City Council will be pressured into a similar bailout. A prospect that becomes all the more likely as the worldwide real estate collapse continues!
Conflicts of Interest.
Developing any piece of property, without employing a TIRZ, creates much more financial benefit to a municipal government, and the taxpayers that it serves, than if a TIRZ is used to build it. Therefore, the most important function of the growing industry of TIRZ consultants is to make the case, for the developer that hires them, that they will not proceed with development without a TIRZ. Since the developer normally already owns the land, and has invested in site plans, before the request for a TIRZ is made; the consultants must be very "creative" and "imaginative" in the assumptions they make to "invent" the "necessity" for a TIRZ. Unfortunately, most city councils are all too willing to believe these often far-fetched tales. This 2004 article in the Houston Chronicle lists 12 projects under development, in Galveston, but surprisingly, only 3 required TIRZs to get built.
These consultants receive such lucrative fees for selling TIRZs to city councils, and "advising" TIRZs and RDAs, that they will go to almost any lengths to convince people to believe their stories about all the wonderful things that TIRZs will do for their cities. Many stand to collect thousands of dollars per month working for TIRZs and RDAs, so they are hardly an objective source of information. Some even make contributions to the politicians that have the power to grant the TIRZ that they are seeking.
One of the most notorious examples of "complex relationships", when it comes to TIRZ consultants, is Vinson & Elkens partner Robert Randolph. "Not surprisingly, perhaps, the chapter of the state law that governs redevelopment authorities was authored by Robert Randolph, who, as it happens, provides contract legal services to more than half of the city's 17 existing TIRZs. According to state ethics commission records, he also lobbies the state Legislature on behalf of a half-dozen tax-increment zones.
State Representative Garnett Coleman, whose inner-city district includes the Midtown and Market Square TIRZs, says Randolph has written many of the tax-increment reinvestment-related bills the legislator has sponsored." Houston Press
Since TIRZs are clearly of dubious value to the taxpayer, why are state legislators, and so many city mayors and council members so anxious to support them?
The mere fact that a TIRZ can be such a sweetheart deal for a developer makes it very tempting to some to "buy" the influence that they need from a politician. This can be done legally through campaign contributions, or illegally by secretly transferring something of value to the office holder.
In the summer of 1999, 1,200 people turned out to oppose the TIRZ requested by Metro National Corporation, in Houston. "In the previous two weeks, Mayor Lee Brown had received more than $30,000 from Metro National executives and the consultants who prepared the corporation's TIRZ proposal. A half-dozen council members had also received contributions from Metro National and its consultants." Houston Press Despite the public outcry against this TIRZ, it was no surprise when it was approved the next day!
Problems of this sort were not limited to elected representatives in Houston. Members of City staff played a big role in trying to sell the so-called benefits of TIRZs to the Council and the public. Some of them entered the revolving door between government employment and the private sector to juice up their earnings, and one person was caught taking money and had to resign. Others just quit the city staff, and became TIRZ consultants.
The taxpayers of Galveston should pay careful attention to those in this city who are a too eager to sing the praises of TIRZs, and who resist any attempts to provide oversight and accountability to their administration. Why don't they want anyone asking the questions that should have been asked BEFORE these TIRZs were granted? This is a debate that the City needs to have in light of what we now know about TIRZs!
TIRZ Boards and the RDA:
With the cost of municipal government already creating a tremendous burden to the average taxpayer, why should they be asked to subsidize developers? It is really adding insult to injury when politicians stick the taxpayers with covering infrastructure costs for 30 years, and then add two levels of quasi-government institutions to manage the projects. This allows the politicians to disavow their responsibility for oversight, AND forces the taxpayers to pay the administration costs of these boards.
"As a public policy, it's difficult to imagine anything as far-reaching and significant as tax-increment reinvestment. Each zone is, in essence, governed not by elected officials, but by appointed boards with the power to spend millions of dollars in property tax revenues unavailable to other areas of the city, whose residents will, as a result, be forced to dip further into the general fund to maintain basic services".
Reportedly, the administration of Galveston's four TIRZs have cost taxpayers almost $1.5 million since 2007. To understand how quickly the consultants can run up these costs, click here and scan through the bills! Notice the fees charged for services that would be totally unnecessary if these TIRZs had not been created.
Multiple Taxing Entities:
TIRZs are normally initiated by city governments, but in most cases other taxing authorities like counties, school districts, libraries, and park districts also share in the property tax revenue. It is up to the cities to convince the other entities to participate, because they can opt out.
Another potential problem addressed by some studies is a city's temptation to reallocate the existing property tax split so that they can receive funds meant for counties, and/or, schools, libraries, and park districts. Galveston County opted in to the TIRZs, in the City of Galveston, which could make some believe that if the City can somehow re-direct County funds to the City; this would be a benefit to the residents of the City. This might be true in a simplistic sense, but as residents of both the County and the City, there would be less money for the County to provide services to City residents, even if it isn't noticeable to most. In addition, many consultants will have to be paid hefty fees to perform this financial slight-of-hand which hurts taxpayers at both the County and City level.
Are There Any Benefits from TIRZs that can Actually be Measured?
Tax-Increment Financing was developed in California, in 1952, but it should come as no surprise that the State of Illinois, the Land of "Honest Government", has used TIF longer, more extensively, and more notoriously than most areas of the country. Mayor Richard M. Daley says that TIF "is the only game in town"!
Professors Richard F. Dye and David F. Merriman have done three extensive studies of TIRZs in Illinois and found absolutely no evidence that property values increase at a faster rate, on a citywide basis, in cities that use TIRZs, than in cities that do not. In fact, they found that citywide property values grew more slowly in cities that employed TIRZs than in cities that did not!!
Let me repeat that. The premier academic study on over 235 Chicago-area municipalities showed that those employing TIRZs stunted the growth rate of their city property values compared to those cities that did not!
"This is consistent with the hypothesis that government subsidies reallocate property improvements in such a way that capital is less productive in its new location."
"These findings suggest that TIF trades off higher growth in the TIF district for lower growth elsewhere. This hypothesis is bolstered by other empirical findings. The larger the share of a municipality’s EAV (Equalized Assessed Values, i.e. property values) that is in the TIF district the slower is the growth in the area of the city outside the TIF district."
"Targeted areas gain from TIF at the expense of non-target areas."
Dye and Merriman 2000
This is the Dye and Merriman simulation of how a TIRZ typically produces the stunted and uneven growth in property values:
"The large increase within the TIF district may look like success to naive policymakers, but it is only part of the impact on the larger community. Our results suggest that the TIF area gain of $1.6 million in property value ($7.7 million minus $6.1 million) costs the non-TIF area $4.4 million (a decline from $115.1 million to $110.7 million). This seems a heavy price to pay to redistribute economic activity.
Dye and Merriman 2000
Dye and Merriman did comment that if a city was willing to trade off a lower growth rate in property values for the city as a whole, in order to boost the growth rate of property values within a TIRZ, in a truly blighted area; that was a legitimate public policy choice. Of course, in Galveston, the TIRZs were set up for high-end luxury housing projects, so according to their findings, to some degree, the growth in property values in the TIRZs, came at the expense of the low-income and middle-class neighborhoods in the City Center; a redistribution of asset values from the poor and middle class to the rich!
At this point, more astute readers are bound to ask why anyone has continued to employ TIRZs, if the net impact on cites has been so NEGATIVE! The answer is simple. The unholy alliance of TIRZ consultants, developers, and the bureaucrats and politicians who have bought into the belief in the magic of TIRZs have no interest in measuring actual results when they can merely point to a new project as "proof" of the wisdom of this concept.
"Raw data on mean annualized EAV (Equalized Assessed Values, i.e. property values) growth rates by TIF status, shown in Table 3, suggest that TIF adoption has a devastatingly negative impact on municipal growth."
"... the EVA growth rate for TIF adoptors was far lower than for non-adopters (4.96% versus 7.38%)."
"On its face, this comparison of pre- and post-adoption means might suggest that TIF adoption costs municipalities more than 2% in EAV growth per year". Dye and Merriman 2000.
As the researchers refined their study, controlling for more and more variables, these are some of their comments:
"Our findings were quite threatening to those with an interest in TIF, such as local economic development officers who spend the earmarked funds or TIF consultants who are paid for documenting findings of “blight” or “but for.”" Dye and Merriman 2006
Their later studies expanded their data base: "We used three different data sets: property value data for 246 municipalities in the six-county Chicago area; less complete property value data for 1,242 municipalities in all 102 Illinois counties; and property value data for 247 TIF districts in the six-county Chicago area."
"In summary, if we make no statistical adjustment for the effects of other determinants, TIF adopters grew more slowly than nonadopters."
Dye and Merriman 2006
The more sophisticated study no longer showed the "provocative" 2.42% per year deficit in growth for cities that adopt TIF districts, but continued to show absolutely no benefit.
"When we use the more recent six-county data in a multivariate regression model with statistical controls for local characteristics and sample selection, we no longer get the earlier provocative result of a significantly negative impact of TIF adoption on growth, but we still find no positive impact of TIF adoption on the growth in citywide property values. Any growth in the TIF district is offset by declines elsewhere."
Their theory on why TIF adoption inhibits overall growth within the municipality is simple: government involvement creates a mis-allocation of resources and inefficiencies compared to the private sector, which is a net negative for the city as a whole. In other words, the favoritism granted by a TIRZ is a form of Crony Capitalism that is good for the cronies, but hurts everyone else. This should be no surprise!
Although the Dye and Merriman studies showed definitive results when comparing annual growth rates of property vales, I could find no studies that addressed the most fundamental problem with TIRZs; the present value of the promised savings is insignificant compared to current costs of the development to the city.
This issue will be addressed in the next and final section.
Cost versus Benefit Analysis:
Trying to accurately analyze an existing Galveston TIRZ would be an exercise in futility, because it would depend on many assumptions and plan projections that attempt to predict conditions many years in the future. For that reason, this analysis will compare a hypothetical TIRZ to a similar development without a TIRZ, so that all future values are known precisely, which should more easily demonstrate the principles involved.
In a mythical land known as Gilligan's Island, there are two identical tracts of beach front property that are totally undeveloped. The Island government is desperate to have this prime property developed to increase the property taxes that it receives. Currently both tracts have an assessed value of $5 million, and pay taxes at a rate of .00666666%, or only $33,333.33 per year.
The Gilligan's Island Economic Development Council envisions projects on this prime property that could add millions of dollars to the tax base, so they send out the word far and wide looking for developers. After discussions with dozens of developers; the tracts were sold to two unrelated buyers, ABC, Inc. and XYZ, Inc.
Both developers want to build a mix of single-family houses and condos for a total of 500 housing units, and 1,000 new residents, on each of their properties. ABC, Inc. is well connected in the political and business circles on Gilligan's Island. Their contacts advise them to hire the top TIRZ consultant on the Mainland. The consultant tells ABC that a TIRZ will not only get the government to cover all of the costs of the project's infrastructure, but due to the favoritism shown to those who are fortunate enough to be granted a TIRZ, they also pay for the costs of significant infrastructure upgrades which will allow them to charge a lot more for their units than if they were built using the Island's standard infrastructure. Of course, just like a complex tax shelter, ABC will have some on-going costs for TIRZ consultants, but they are still very excited by how much the upgrades will boost their profits!
The Gilligan's Island Council hears a presentation by the TIRZ consultant who tells them that "without a TIRZ; ABC may not build for another 20 years, if ever", but if they grant them a TIRZ, "they will put millions of dollars worth of property on the tax rolls right now". Buying into the story, and fearful of losing this project, Council votes 7 to 0 to give a 30-year TIRZ to ABC, Inc.! Because the Council will provide them with an upgraded infrastructure, at no cost, ABC will be able to sell their units for a total of $200 million!
The Gilligan's Island RDA sells a 30-year $25 million muni-bond to finance the upgraded infrastructure for this plan. The increment should cover the interest, the sinking fund, and the TIRZ and RDA management fees.
XYZ, Inc. has no political connections on the Island, so they approach the Council merely to get their plan approved, and to ask for help with building out their infrastructure. Council is a little shocked that they were told that they had to give ABC a TIRZ, or they wouldn't move forward with development, and now another developer is ready to build right next to them without a TIRZ! This time the Council thinks that don't have to give up anything to get more development. Why would XYZ have purchased the land, and done site plans, if they didn't intend to build? Somehow they failed to ask that question when ABC came to them asking for a TIRZ, but Council has now learned that they gave away too much to ABC. Council tells XYZ that they must pay the full cost for their own infrastructure. The minimum required infrastructure will cost XYZ $10 million. They could choose to make the same upgrades that ABC will employ, but if they have to pay for it themselves, the added risks, and the financing cost will be too high, so they opt for the required minimum. Due to the extra $10 million that they have to spend, compared to ABC, XYZ feels they will have to be satisfied with a project that will only sell for $150 million, and it will be far less profitable than ABC's.
To make the math simple, in this example, construction of all the housing units will be completed instantly, so that further assumptions don't have to be made about how long it takes to complete the build out. Therefore, at the beginning of year 1, the assessed value of the ABC project will increase by $200 million, and the XYZ development will increase by $150 million. The 500 new housing units, and 1,000 new residents, will create an additional yearly cost for government services of $1 million for each project. However, each 1,000 new residents will generate $635,000 per year in additional sales tax!
On Gilligan's Island, inflation runs 3% every year, so all costs and assessments in this example will go up 3% every year.
The data in following the table clearly illustrates how the relatively small deficits in early years from the ABC project add up to big deficits by the time the scheduled end of the TIRZ is reached, simply because it takes so many years to get to that point! ABC's manageable $365,000 deficit in year 1 has ballooned to a total of $17,365,026 by year 30! This is the amount that Gilligan's Island has spent on government services, for the residents of this project, over the life of the TIRZ, in excess of revenues from sales tax generated by the new residents. This is because all of the additional property tax, i.e. the Increment, has financed TIRZ infrastructure and management costs rather than going to the general fund.
However, in year 31, a big $3,236,349 property tax payment finally kicks in and starts paying down the $17,365,026 deficit, so by year 37, the Gilligan's Island government is finally enjoying a positive net cash flow!
Of course, if very many of the 500 beach-front housing units in this TIRZ were sold as second homes, the sales tax generated by weekend home owners would likely be far below the $635,000 per year used in this example, which would create a much larger deficit for the government.
It is almost impossible to make the case that it is good public policy for the current residents of Gilligan's Island to pay for something that they can't possibly benefit from for almost four decades; i.e, two generations! Many of the people who are forced to pay for this project will have moved away, or will no longer be alive, when it actually begins to benefit the taxpayers. When a cost/benefit analysis is run on a typical TIRZ, such as this hypothetical example, the obvious response to the claim that it can't be built without a TIRZ should be; so what! There is virtually no benefit from the project to the current residents of the city, so why should they make any sacrifice to help build it?
Therefore, all that should be asked is, Cui bono?
In spite of all the hoopla about TIRZs, the next table demonstrates that the comparison non-TIRZ project built by XYZ, Inc. generated a positive cash flow to the government immediately upon its completion, and every year after that, even though it's property is less valuable than that in the TIRZ development!
In year 30, when ABC's TIRZ should terminate, the government had a deficit of $17,365,026 due to the TIRZ, but it had accumulated $30,210,388 in revenue from XYZ's non-TIRZ project. Therefore, the non-TIRZ project had contributed $47,575,414 more than the TIRZ project to the general fund!
Where is the advantage of the TIRZ to the government, and, therefore, to the taxpayer? Wait for it! Scrolling down both tables reveals that the net revenue from the TIRZ project finally surpasses the non-TIRZ project in year 65! The results from the TIRZ development are shown to be even worse when compared to a non-TIRZ development!
As was stated above, it is nearly impossible to make the case that it is good public policy for the current residents of Gilligan's Island to pay for something that they can't possibly benefit from for more than six decades, or three generations; when compared to the more conservative way of financing infrastructure!
About the only argument that the TIRZ promoters can fall back on is that neither of these projects would have been built without a TIRZ, but if that is actually true, it isn't worth an investment by the taxpayers in their infrastructure. If neither gets developed, that's just fine!
I am appalled!
When I began the research for this article, I assumed that TIRZs were relatively harmless monuments to government inefficiency and excess; just another layer of wasteful bureaucracy. However, as I learned more and more, I kept hearing the theme song from the movie "The Sting", and remembered the classic cons portrayed in the film. One of the lessons the successful grifters taught the new comers was to finish a con in such a way that the mark never knows that he has been had, because if he does, he may come looking for revenge. If the mark never learns that he has been conned, the grifter is home free. This seems to be the principle being employed by the TIRZ consultants who make a very good living by promoting this idea. After they sell a city on TIRZs, they continue to maintain the con by "advising" TIRZ boards on how to hide what is really going on from the voters.
Their pitch is simple. If you authorize a TIRZ, "we will help you put property on your tax rolls that would never be there without the TIRZ". Even better, "it will not cost the city anything, because the Increment will pay for it". "Using the Increment costs nothing, because there would be no Increment without the TIRZ". They should finish their pitch by selling the manufacturing rights to a perpetual-motion machine!
What their pitch conveniently leaves out is the simple fact that if a city can't finance the infrastructure for new development in a better way than using a TIRZ, then they shouldn't fund it at all, because the city, and, therefore, the taxpayers will not see any benefit from the Increment for decades. If TIRZs fail, the payoff could be delayed for many more years.
The sweetheart deal offered by a TIRZ creates enormous conflicts of interest, and opportunities for corruption in local government. The TIRZ boards allow developers to control the reimbursement process, and upgrade the infrastructure to boost their profits, while paying TIRZ consultants unreasonable fees to maintain the appearance that this is a good deal for the taxpayer. All this is done even though studies by Dye and Merriman demonstrate that TIRZs actually retard the growth of property values in the areas outside of the TIRZ, and a simple cost/benefit analysis shows that current taxpayers will have to wait as long as 40-65 years for a TIRZ development to offer the same benefit to them as a non-TIRZ development.
The counter-attack against facts like these is an effort to make sure that the taxpayers never learn that they have been conned!
Do you hear the theme song from "The Sting"?
In a way, it was comforting to find out that Galveston is not the only city to fall for this con. There are thousands of TIRZs around the country, so many people have fallen for "the pitch". TIRZs will probably play a lead role in bankrupting the City of Chicago, they are likely to cause significant financial damage in Houston, and the potential fallout to Galveston's precarious government finances could be devastating.
Now that the facts are being revealed, it is time to stop allowing those in City government, who are still repeating the mantra that our TIRZs have "put millions of dollars of property on the tax rolls that would not be there without them", to stifle debate! It is time to determine how to mitigate the damage from our TIRZs. Ideally, a way can be found to unwind them, over a period of a few years, and make them null and void.
Many will say that these TIRZs are valid contracts, so the City of Galveston is stuck with them. They certainly are contracts; but are they valid? Contracts can be declared null and void by the courts, if they are found to be unconscionable, because the consideration to one party is so grossly unfair as to infer fraud. In other words, if the consultants misrepresented the benefits, and failed to adequately disclose the costs of a TIRZ to City representatives, who can be shown to have been "unsophisticated" in their ability to understand this type of transaction; then there could be sufficient grounds to set aside these contracts.
The TIRZ consultants were advising the City government to adopt the TIRZs in question, as they stood to make a fortune from their formation and operation without any real benefit to the City.
One way to demonstrate the inadequate consideration, and, therefore, the unconscionability of a TIRZ, is for the City to switch positions with the developer. For example, in the hypothetical TIRZ calculations in this article, would ABC, Inc. be willing to pay all infrastructure costs, and in return receive nothing more than the sales tax generated by their new residents for the first 30 years, while they wait to get their first payment from the Increment in year 31? Will the developer be willing to wait 37 years before they are made whole on their investment in the infrastructure?
If the Galveston City Council is unwilling to move forward to reverse the actions of earlier Councils that saddled the City with these TIRZs, the City will continue to pay a high price. At the very least, Council needs to make it clear that there will be no more TIRZs added to the list in this city. It is even possible that a resident or citizens group will file suit to have them reversed, as was done in Chicago. Just the depositions from such a suit would be extremely interesting and informative!
If Council continues to assert that these TIRZs are good for the City, then the easiest way to eliminate the controversy surrounding their use is to remove the favoritism and cronyism involved by declaring the entire Island a TIRZ! If it is good for some, then it should be good for all. At least that would allow the entire Island to be governed by just one TIRZ board, which would save the taxpayers a great deal of money. Such a Galveston Island TIRZ would put all of the increased property tax from all future growth in property values, on the entire Island, into an Increment that could not be used by City government for 30 years. The TIRZ board would be free to spend it as it sees fit to "facilitate development". Many City services may not get funded, but it would only continue and increase the effects of the existing TIRZs, which should be acceptable, if the benefits are as good as claimed by the promoters.
How does that sound?
Steven G. Craig
Richard F. Dye
David F. Merriman
Richard F. Dye and David F. Merriman:
The Effects of Tax Increment Financing on Economic Development
The Effects of Tax Increment Financing on Land Use (Chapter 2 in "Property Tax, Land Use, and Land Use Regulation" Edited by Dick Netzer
Tax Increment Financing: A Tool for Local Economic Development
Brian Wallstin, Houston Press:
Looking For Answers Down Below
City Pork Project
Working Every Angle
Houston's Big Experiment
The Chicago Reader Series on TIF
A Tale of Two Cities; Reinventing TIF
Galveston County on TIRZs
TIF; Opportunities and Concerns
For more information on the Galveston Economy: Click Here
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