Tax Increment Financing: A Quick Primer

Cities seeking to spur development in underinvested areas have a number of tools at their disposal to entice developers. These tools include zoning changes, density bonuses, improved infrastructure, tax-related incentives, and more. All carry their own benefits, risks, and drawbacks, but within the broad tax category is a particularly interesting approach called tax increment financing (TIF).

How does it operate?

TIF has been succinctly defined as “a targeted development finance tool that captures the future value of an improved property to pay for the current costs of those improvements.” It does this by:

  1. Creating a TIF district – a TIF district (or authority) is created composed of the property/properties to be developed as well as surrounding lots
  2. Freezing assessed value within the TIF district – the assessed taxable value of property within the district is locked or frozen at pre-development level. This base tax level will continue to flow to the local or state tax authority for the remainder of the district’s life (e.g. 20 years).
  3. TIFDiverting additional value to the TIF – any additional taxable value that the district enjoys during the term of the TIF district is diverted to that authority.
  4. Paying for improvement through the TIF – that new revenue is used to fund improvements within the district, including those the district (or another authority) may have paid for at the start (outright or through a bond) to catalyze the growth.
  5. Benefiting the state/city budget after TIF term ends – After the TIF district concludes, the full taxable value of the property within the district can be taxed by the traditional state/local body.

What can TIF money be used for?

TIF funds are used to finance activities or pay off debt for costs related to “public infrastructure, land acquisition, demolition, utilities, planning, and more. TIF funds have also been used to help support community amenities such as parks, recreational facilities, schools, and network infrastructure.” (source)

How do TIFs help government pay for results?

A government could encourage private infrastructure improvements by promising to reimburse all or some of those costs through increases in property taxes captured by the TIF. While it’s hard to prove that any occurring growth is indisputably caused by those improvements (see counterfactual criticism, below), this provides a potentially more attractive model than seeing no improvement or having government paying for the infrastructure outright, especially in risky projects where the benefit is uncertain. In this sense there is, at least theoretically, more accountability to results than some other tools at government’s disposal to encourage growth.

Does it work?

Almost every state authorizes use of TIF and, once allowed, it’s almost entirely up to local jurisdictions (cities and counties) whether to use it.

In Chicago alone, there are nearly 150 TIF districts. While TIF is a particularly well-used tool in Chicago, they are common in communities across the United States. The promise of TIFs – encouraging development in blighted areas through improvements that pay for themselves – is attractive and is undoubtedly behind their widespread adoption. However, is there evidence that they’re successful at encouraging economic growth?

This question is complicated by one of the biggest criticisms of TIF: that they are unnecessary and, further, benefit private interests to the detriment of the public treasury. This argument questions whether development in a TIF district would have occurred without the TIF with the result that money that should be flowing to city schools are instead being used to fund developer giveaways.

While it’s challenging to do a randomized controlled trial with blocks of land, we can compare districts with a TIF to similar districts without one and seek to measure key economic metrics like jobs, land value, economic growth, etc. The evidence thus far, while far from conclusive, isn’t kind to TIF:

  • One study from Iowa found no net economic benefits from TIF districts.
  • Another, from Illinois concluded that faster commercial growth in TIF districts may be offset by slower growth in nearby non-TIF districts – in other words, growth isn’t created, it’s just redistributed locally.
  • A 2003 ‘community perspective’ study from Chicago found that “Tax increment financing has not been proven to be effective at generating either jobs or new businesses [and] has an ambiguous effect on housing markets, determined partly by how TIF districts are designed, but usually harms low-income renters and homeowners.”
  • A detailed study of TIF usage in Northeastern Illinois found that for a third of TIF districts, property value growth was less than in non-TIF districts in the same municipality.

In addition, TIF has been criticized ideologically as a form of ‘crony capitalism’.  Additionally, there is concern that during the terms of the TIF, the model forces non-TIF areas to take a higher share of the local tax burden.

Unfortunately, there is still limited evidence of the effectiveness of TIF and most of the existing evidence is small scale and concentrated on a few high-usage jurisdictions (notably the Chicago area). Ultimately, TIF may be a tool best suited to a few cases but, like many public policy tools, indiscriminately overused by policymakers.

Venture Capital: Relative Distribution Across US Cities

Richard Florida and Karen King at the Martin Prosperity Institute published a report called Spiky Venture Capital, showing how venture capital (VC) clustered around a few metropolitan areas. In fact, they found:

Venture capital investment is concentrated in three broad clusters which account for more than 80 percent of all investment: the San Francisco Bay Area, which spans San Francisco, San Jose, and several smaller metros; the Boston-New York-Washington, D.C. Corridor; and Southern California, spanning Los Angeles, San Diego, Santa Barbara, and Orange County.

For policymakers, the relative clustering of VC also matters. In other words, how much more (or less) VC is attracted to a certain metropolitan area than you would otherwise expect based on its population. For instance, if a metro area attracted 20% of the US’s VC but had only 5% of the US’s population, you could say it outperforms expectations (based on population) by four times.

Drawing from Florida and King’s study, I looked at the 20 largest metropolitan areas for VC, ranked by their share of US VC and compared this to their share of US population (based on 2015 Census estimates):

VC relative

This table is color coded, with cities who underperform VC attraction relative to their population are in red, cities that attract VC 1 to 3 times what their population size alone would predict are in yellow, and cities that attract VC >3 times what their population proportion would expect are in green.

Green cities (super performers) are the “usual suspects” of VC: San Jose (Silicon Valley) outperforming its population by 23.5 times, San Francisco (17.4 times), Boston (6.4 times) and Santa Barbara, CA (5.4 times). Moderate out-performers include some of the country’s largest metropolitan areas, including NYC, LA, and DC, as well as relative start-up hubs like San Diego, Seattle, Austin, Denver, and Raleigh, NC. Some of the under-performers are perhaps unsurprising (e.g. Houston) but for others, like Philadelphia and Chicago, this should be a major wake up call.