TIF for Tat: The Folly of Tax Increment Financing

Tax increment financing, or TIF, has become an increasingly common and acceptable form of “innovative financing” for state and local governments. The idea is simple: public investments should improve the economic viability of cities and neighborhoods, increasing property values. The property taxes generated from the increase in the property values (the tax increment) can be used to finance government investments in neighborhoods. In theory, TIF has the potential to increase transparency and reduce general tax burdens by incorporating a user pays principle into government financing for targeted investments.

In practice, TIF has been used to finance boondoggles and subsidize businesses. The potential pitfalls of adopting TIFs are becoming legend, and Reason magazine had an article recently by Daniel McGraw that highlighted some of these excesses. Most recently, the Heartland Institute published a nice short piece highlighting the failiure of TIF to fund $200 million in subsidies extended to Sears to move their corporate headquarters to suburban Chicago.

Still, TIF may have a role in financing a limited number of public investments if they are designed properly. That’s the rub. Most TIF programs are designed as elaborate schemes to funnel subsidies to private firms and organizations, or to promote various social welfare objectives such as affordable housing. The result is that cities that use TIF are no more likely to grow than those that don’t use them, when other factors that contribute to growth are considered.

A good overview of the potential impact of TIF programs on economic development can be found in an article by economists Richard Dye and David Merriman for the Lincoln Institute of Land Policy. After analyzing hundreds of TIF programs in different cities and counties, they conclude:

“Tax increment financing is an alluring tool. TIF districts grow much faster than other areas in their host municipalities. TIF boosters or naive analysts might point to this as evidence of the success of tax increment financing, but they would be wrong. Observing high growth in an area targeted for development is unremarkable. The issues we have studied are (1) whether the targeting causes the growth or merely signals that growth is coming; and (2) whether the growth in the targeted area comes at the expense of other parts of the same municipality. We find evidence that the non-TIF areas of municipalities that use TIF grow no more rapidly, and perhaps more slowly, than similar municipalities that do not use TIF.

“Policy makers should use TIF with caution. It is, after all, merely a way of financing economic development and does not change the opportunities for development or the skills of those doing the development planning. Moreover, policy makers should pay careful attention to land use when TIF is being considered. Our evidence shows that commercial TIF districts reduce commercial property value growth in the non-TIF part of the same municipality. This is not terribly surprising, given that much of commercial property is retailing and most retail trade needs to be located close to its customer base. That is, if you subsidize a store in one location there will be less demand to have a store in a nearby location. Industrial land use, in theory, is different. Industrial goods are mostly exported and sold outside the local area, so a local offset would not be expected. Our evidence is generally consistent with this prediction of no offset in industrial property growth in non-TIF areas of the same municipality.”

The point is not that TIF can never be a useful approach to financing a public investment. Rather, its value is limited, and the broader implications need to be considered. A TIF working on its own will not revitaize a city or neighborhood. The “preconditions” for growth still need to be in place. In addition, for commercial TIFs, the likely impact is to reshuffle growth. In short, a TIF does not necessarily (and is unlikely to) finance truly new development.

Where would a TIF make sense? In my view, TIF should only be considered to fund a long-term public investment, such as roads or other transportation infrastructure that improves access in a local area. These investments must have tangible, measurable, and localized benefits. The TIF would serve as an alternative to financing from general taxes and avoid the current practice of subsidizing improvements in one area at the expense of another. When designed properly, TIF can be a form of a user fee where the beneficiaries (land owners and businesses benefiting from the investment) pay for the infrastructure without burdening the rest of the community.