Tax Increment Financing – a viable new funding stream?

In hard times, regeneration is often the first aspect of development to be abandoned. Without private sector investment – which historically has kept regeneration schemes alive – local authorities and developers simply don’t have the cash to fund such schemes. Lending conditions remain tough, and new and existing funding streams, such as the Community Infrastructure Levy and Regional Infrastructure Funds, are considered insufficient to support future regeneration.

Enter Tax Increment Financing (TIF), an American model that is being seriously mooted in Britain. Pioneered in California in 1950, the concept of TIF involves capturing anticipated incremental tax revenues to pay for enabling infrastructure within a regeneration scheme that would otherwise be stalled. In other words, it allows councils to borrow cash to pay for said infrastructure, on the back of the projected tax hikes that will occur as a result of the development.

Back in April, the Chancellor indicated that the government would explore the viability of TIF (interpreted here as Accelerated Development Zones) as a means of fuelling economic growth. Local authorities submitted proposals for pilot schemes; the successful few should be announced in the Pre-Budget Report this Autumn. One of the most advanced proposals comes from Edinburgh City Council. According to the plan, £50m of upfront investment is required to fund, among other elements, a lock gate, a new pier and a new road on the waterfront. The council could receive up to £310m in additional business rates over the next 25 years, and attract £450m of investment into the area.

Dave Anderson, director of city development at Edinburgh City Council, explains that this project wouldn’t go ahead without TIF: “We’re trying to use public funds at this stage to pump-prime the market and kick-start recovery of development in that part of Edinburgh. Some parts of the waterfront are in negative land values at the moment, so clearly it doesn’t make sense for developers to proceed.”

There is mounting support for TIF in this country, from both the public and private sectors. Indeed, property giants, major retailers and big city councils have all backed the idea. But could it really work here? The BPF argues that it could help us through the recession by attracting new investment into the country, help prevent ‘blighted’ areas slip into further decline and restore confidence. Indeed, TIF has proved to be a powerful tool in the US in jump-starting regeneration. Sarah Whitney, managing director of the regeneration and development teams at CB Richard Ellis, is cautiously optimistic: “If introduced, it would be in a modest way. I think there would be very high hurdles for local authorities and developers to jump, and it’s not a panacea – there are some schemes for which it would never work. It’s not just about plugging a funding gap in a development appraisal, but it is another tool in the box when you’re looking at how to fund enabling infrastructure.”

The devil is in the detail
While the concept of TIF is fairly simple, putting it into practice is rather more complex. It would require enabling legislation for a full national scheme, in order to divert business rates from the Treasury to local authorities, with strict preconditions and appropriate oversight. As CB Richard Ellis (CBRE) and DLA Piper point out in a joint report, it would also require some decentralisation. In parts of America, safeguards include limiting the property tax base within each state, and even a requirement for taxpayer votes before a scheme is introduced.

So, who pays? Councils will most likely take on the debt through prudential borrowing – at least initially. Most critically, though, is how to underwrite this type of funding. TIF poses a substantial risk should plans go awry, with repayments taking up to 25 years. However, as the All Party Urban Development Group (APUDG) argues, the cost of private financing may be prohibitively high if there is no central government guarantee.

There is also an obvious difficulty in estimating the future tax increment, due to the complexity of the business rating system. But, says the BPF, this is by no means insurmountable: it may not be possible to forecast the increase perfectly, but we can look to American examples in reducing the margins of error and reach appropriate estimations.

Another hitch is the displacement of taxes, whereby a new development pinches business from a neighbouring district. Chris Brown, chief executive of Igloo Regeneration, says: “The reason [some] TIFs have gone very badly wrong in the States is that property developers come along and say, ‘My scheme is going to generate $100m’, and not saying that it is just being sucked from elsewhere.” The APUDG suggests the use of oversight via an appropriate government agency, and clear rules to help to contain taxes and stimulate a genuine uplift.

The purpose of TIF is to stem blight and the criteria for granting TIF status should reflect that. Yet critics warn of the abuse of TIF in America, where rules have been bent to fuel competition and increase revenues. For instance, the BPF reports that an industrial park and Wal-Mart centre were built on farmland in Wisconsin, where ‘blight’ was defined by a single, uninhabited house in the district.

Reaping the rewards
Enough of the risks – what about the benefits? Sarah Whitney from CBRE explains: “The beauty is that there will obviously be new business rates on a new [regeneration] scheme, which then fund the infrastructure. As people move in, there are new corporation taxes, VAT, payroll, stamp duty, land and council taxes being generated. So from the government’s perspective it’s worth investigating; they might lose the benefit of business rates while it’s being generated but they will benefit from all those other taxes.”

As pointed out by CBRE/DLA Piper research, the initial tax base is frozen, therefore the rise in tax revenues is incremental rather than new. Schemes therefore incur ‘no new tax and no lost tax’. And in the long term, the council will benefit from the entire incremental tax as well as the frozen tax base once the upfront investments are paid.

Research suggests that the public sector will have to change its attitude to risk, and work in closer partnership with the private sector to get results. But this also means that the public sector will benefit from longer-term rewards. Edinburgh City Council’s Anderson isn’t put off by the associated risks with TIF-style funding: “The evidence from America is that in areas that are growing in a dynamic like Edinburgh, this model can work, but it’s not something to try in an economy where there is endemic market failure and no real vision for future growth.”

Clearly, every TIF-enabled project will involve some risk and some cost. But the BPF believes that it can be structured in such a way that there will only be winners. Peter Cosmetatos, director of finance and investment at the BPF, explains: “We know that TIF can be quite complex. But we are confident that the proper structures can be put in place to manage the risk and cost involved, and therefore ensure that everyone can reap the maximum benefit – the private sector, local government, the Exchequer and, most importantly, the community.”